What you will learn to do: create a cost-volume-profit model.

The Cost-Volume-Profit (CVP) model is based on the idea that certain costs vary with volume, and other costs are fixed. If you have a boat that costs $4,680 to make and sell, and you sell it for $6,000, you have $1,320 left to cover fixed costs and profits. Therefore, if you sell two boats, you make $12,000 in sales revenue, but you had to spend $9,360 to do it (4,680 X 2), leaving you $2,640 to cover fixed costs and profit. The amount left over after paying the costs that vary is called contribution margin.

This relatively simple mathematical relationship is at the heart of CVP analysis.

(Sales – Variable Costs) = Contribution Margin

Contribution Margin – Fixed Costs = Profit (also called Operating Income)

In order to create the model, you will have to sort out fixed costs from variable costs and then apply a logical comparative approach to your analysis, and you’ll have to relate that information back to your boss and reconcile it to the financials she has presented to you.

When you are done with this section, you will be able to:

• Understand the relationship between fixed, variable, and total costs
• Calculate contribution margin and contribution margin ratio

Learning Activities

The learning activities for this section include the following:

• Reading: Variable and Fixed Costs
• Self Check: Variable and Fixed Costs
• Reading: Contribution Margin
• Self Check: Contribution Margin