Why It Matters: Cost-Volume-Profit Analysis

A sailboat on the water with a sunset in the background.Businesses focus on profitability and look for ways to improve operational performance by analyzing projected or actual financial information. One relatively simple strategy is to look at cost behavior, which is how costs respond to changes in sales volume. Knowing how costs behave helps managers forecast operating income based on sales volume. This insight also helps managers estimate costs related to the decisions they make in the business.

Suppose you have been hired by Classic Boats, Inc. to provide information to management to help turn the company around. Your new boss hands you the following information for the month of July, compiled by the financial accounting staff:

Classic Boats, Inc.
Income Statement
For the month ending July 31, 20XX
Description Amount Total
Sales $   156,000.00
Cost of Goods Sold $   122,000.00
Gross Profit Single Line$    34,000.00
Selling, general, and administrative costs $    34,680.00
Operating income Single Line$     (680.00)
Provision for income taxes $            –
Single Line$     (680.00)Double line

Her question to you is simple: Why are we losing money, and what do we have to do to make money?

She also notes that the company sold 26 custom sailboats in July at a price of $6,000 each. She can see that the SGA (selling, general, and administrative) costs are higher than the gross profit from sales, but she needs you to come up with more detailed information so that she can make some tough decisions.

You retreat to your office to think and do some research. As you are thinking and searching for the best way to tackle this problem, you recall reading about a way to look at financial data using a CVP model to show how changes in sales volume, prices, and costs affect profits.

Cost volume profit (CVP) analysis is a managerial accounting technique used to determine how changes in sales volume, variable costs, fixed costs, and/or selling price per unit affect a business’s operating income. The focus may be on a single product or on a sales mix of two or more different products.

The results of these analyses help managers make informed decisions about products or services they sell, such as setting selling prices, selecting combinations of different products to sell, projecting profitability, and determining the feasibility of offering a product or service for sale.