Components of Cost-Volume-Profit (CVP) Analysis
CVP analysis shows how changes in a company’s sales volume affect its profits. There are five main components of CVP: unit selling price, level of activity, unit variable cost, total fixed cost, and the sales mix. These basic components of CVP analysis are interrelated based on various assumptions. The level of activity affects the costs and revenues of the company. The unit variable cost is ascertained by dividing total variable cost with the level of activity.
How a CVP Income Statement helps Management to make Decisions
A CVP income statement examines the costs and revenues of a company over a period and it also indicates the contribution margin based on these costs and revenues. The statement shows how each product contributes to the company’s profit and it helps management to choose the most profitable product mix for the company.
Advantage of Offering a Discount
It will increase sales volume and revenues.
It will lower per unit contribution margin.
The advantage of not offering a discount:
The per unit contribution margin will not be affected.
This may lower the sales volume and, hence, lower the company’s revenues.
Deciding on the Discount
In case the airline is going to offer a discount, the discount offered should be that which maximizes the company’s contribution margin per unit, taking into account the effect of the discount on sales volume and revenues. The discount is bound to lower the company’s selling price per unit while increasing sales volume.
Break-even analysis involves determination of the break-even point (BEP) which is that point at which a company’s total costs equal its total revenues. In CVP analysis, break-even point is achieved when the company’s profit is zero. To lower the break-even point, a manager can try to reduce variable costs by seeking cheaper suppliers, reduce fixed costs, or raise the selling price.