Cost volume profit analysis helps business owners see their product costs in a new light. Follow these steps the next time you need to price a product or create a profit target.
There’s a lot about opening a small business that will surprise you, like how hard it is to hire and retain top talent and the fact that a dozen cups of coffee can’t replace a good night’s sleep.
You can save yourself one surprise by estimating your profit margins with a cost volume profit analysis.
Overview: What is cost volume profit analysis?
Cost volume profit (CVP) analysis reveals how many units of a product you need to sell to cover your costs or meet a profit target. It’s a type of breakeven analysis that shows business owners how changes in costs and sales affect business profits.
Say you own a pajama company named Sleepy Baby LLC. You can use CVP analysis to tell you how many pajama sets you’ll have to sell to earn a $50,000 profit. I can tell you now that it’ll be a lot of pajama sets; we’ll get to a more precise answer later.
CVP analysis also helps manufacturers decide on selling prices and how many units to produce. Businesses use CVP analysis to play out “whatif” scenarios, plugging projected sales numbers into the CVP equation to see how it affects the business’s bottom line.
Businesses visualize CVP analysis through graphs and CVP income statements.
What is the cost volume profit formula?
CVP comprises a collection of formulas that shed light on the relationship among product costs, sales volume, selling prices, and profits.
Before we dive into the formulas, let’s define a few terms:
 Fixed costs: These are the costs your business incurs that don’t change based on the number of units manufactured. Expenses like rent, insurance, marketing, and depreciation count as fixed costs.
 Variable costs: These are the costs that increase in lockstep with units. For example, raw materials are a variable cost because more units require additional material.
 Unit contribution margin: Once you know your fixed and variable costs, you can get some insight into how much each additional unit “contributes” to your bottom line, or the unit contribution margin. It is yielded by the formula
Unit Selling Price  Variable Costs Per Unit = Unit Contribution Margin
 Contribution margin ratio: This is just another way of looking at your unit contribution margin as a proportion of sales price rather than in dollars. This is calculated by the formula
Unit Contribution Margin ÷ Unit Selling Price = Contribution Margin Ratio
Now we’re ready for some CVP formulas.
There are four formulas in all. The first two tell you how much revenue you need to earn or how many units you need to sell to break even  just covering your costs and earning $0 income.
BreakEven Sales Volume ($) = Fixed Costs ($) ÷ Contribution Margin Ratio (%)
BreakEven Sales Volume (units) = Fixed Costs ($) ÷ Unit Contribution Margin
The following two add in a profit target. Use these to find the path to earning a specific profit.
Target Sales Volume ($) = (Fixed Costs [$] + Profit Target [$]) ÷ Contribution Margin Ratio (%)
Target Sales Volume (units) = (Fixed Costs [$] + Profit Target [$]) ÷ Unit Contribution Margin
How to perform a cost volume profit analysis (CVP) analysis
You’ll need no more than a firm grip of your costs and a little time to conduct a CVP analysis.
1. Sum fixed costs
Tally your company’s fixed costs:
 Rent
 Insurance
 Salaries
 Property tax
 Marketing
 Accounting
 Legal
 Equipment or depreciation
 Utilities
Not every account in your books is strictly fixed or variable. For example, your utilities have fixed and variable components: Internet and phone bills don’t change with usage, but electricity does. Split these expenses into fixed and variable categories to the extent that you can.
Of course, you can make a big todo about bifurcating semivariable costs using statistical regression. But if the word “statistical” makes you feel sick and you’re satisfied with a quickanddirty CVP analysis, you can treat all utilities as fixed expenses.
Your accounting method plays a role in what’s included in fixed costs. For example, cash method businesses don’t have noncash expenses like depreciation and amortization. For tax purposes, you still depreciate fixed assets  think machinery and heavy equipment  but you might not have such an account in your accounting software. Instead, you expense the full amount of equipment purchases when you pay for them.
For accrual method businesses, depreciation and amortization count as fixed costs because they don’t change with the number of units your company sells. Since they’re noncash expenses that don’t affect your business’s cash profits, you might choose to leave depreciation and amortization off your CVP calculation.
2. Determine the product’s selling price
CVP analysis can assess whether your target selling price gives you the profits you desire. You might return to this step many times before arriving at a selling price that works for your business.
3. Calculate the variable cost per unit
Variable costs increase for every additional unit your business produces. Add the following to find variable costs:
 Direct material (DM): Raw materials that go into your final product
 Direct labor (DL): Hourly for workers who create your final product
 Variable manufacturing overhead (VMOH): Hourly wages for manufacturing supervisors, shipping, and supplies for machinery
You’ll want the variable cost on a perunit basis for the CVP analysis. For example, a pajama manufacturer might say it takes $5 in direct material, $5 in direct labor, and $10 in overhead to produce one set of pajamas. The variable cost per unit is $20 ($5 DM + $5 DL + $10 VMOH).
Learn more in our guides to variable costs and total manufacturing costs.
4. Calculate the unit CM and CM ratio
Subtract your variable cost per unit from the unit selling price. The difference is contribution margin, which tells you how much profit is left to cover fixed costs.
To find the CM ratio, divide CM by the unit selling price. The result should be between 0 and 1, which is the percentage of your selling price that goes toward paying fixed costs.
5. Complete the CVP analysis
You’re finally ready to complete the CVP analysis. Plug your values into each of the four CVP formulas to uncover the number of units you’ll need to sell to reach your profit goal.
BreakEven Sales Volume ($) = Fixed Costs ($) ÷ Contribution Margin Ratio (%)
BreakEven Sales Volume (units) = Fixed Costs ($) ÷ Unit Contribution Margin
Target Sales Volume ($) = (Fixed Costs [$] + Profit Target [$]) ÷ Contribution Margin Ratio (%)
Target Sales Volume (units) = (Fixed Costs [$] + Profit Target [$]) ÷ Unit Contribution Margin
A cost volume profit analysis example
Let’s address the cost volume profit analysis example I referenced earlier. The question is: How many pajama sets does Sleepy Baby LLC need to sell to earn a $50,000 profit in its first year of operations?
1. Sum fixed costs
Sleepy Baby’s fixed costs for the year are below:
Fixed costs come to $33,050.
2. Determine the product’s selling price
If you’re using CVP analysis to price your product, this step is iterative. We won’t know until the end whether the selling price we choose will suffice.
Sleepy Baby conducted market research and found that customers are willing to pay up to $150 per pajama set, so let’s make $150 the selling price for the CVP model.
3. Calculate the variable cost per unit
To find each pajama set’s variable cost per unit, investigate how much direct material, direct labor, and variable manufacturing overhead is required.
 Direct material is $25 since each pajama set requires one yard of ultrasoft fabric at $25 per yard.
 Direct labor is $2 because it takes 0.2 hours for a factory worker who’s paid $10 per hour to make one pajama set ($10 per hour ✕ 0.2 hours).
 Variable manufacturing overhead is $3 per unit for shipping goods to a wholesaler.
Sleepy Baby’s variable cost per unit is $30 ($25 DM + $2 DL + $3 VMOH).
4. Calculate the unit CM and CM ratio
Subtract variable cost per unit from the unit selling price. The unit CM is $120 ($150 unit selling price  $30 variable cost per unit).
The CM ratio is 0.8 or 80% ($120 unit CM ÷ $150 unit selling price).
To translate from accounting to English, Sleepy Baby earns $120, or 80% of the selling price, per pajama set before accounting for fixed costs.
5. Complete the CVP analysis
Let’s return to the question: How many pajama sets does Sleepy Baby need to sell before earning a $50,000 profit?
(Fixed Costs [$] + Profit Target [$]) ÷ Unit Contribution Margin = Target Sales Volume (units)
($33,050 + $50,000) ÷ $120 = 692
When you plug all the known variables into the target sales volume formula, you learn that Sleepy Baby needs to sell about 692 pajama sets to reach $50,000 in profit.
Sleepy Baby can use the CVP results to decide whether it has the capacity to produce and sell 692 pajama sets.
You most commonly see CVP analyses explained through graphs like the one below. While fixed costs remain constant at $33,050, total costs increase in proportion to units. Once sales and total costs intersect at the breakeven point, all you see is profit.
CVP analyses are most often communicated through charts. Image source: Author
2 advantages of using the cost volume profit analysis
A CVP analysis brings your business new insights without wasting too much of your time.
1. It breaks down your costs in a new way
A CVP analysis forces you to think about your product costs in a new way. Compartmentalizing expenses into fixed and variable components brings attention to the fact that not all costs increase as your business increases production.
2. It’s quick
Compiling all the information needed for a CVP analysis might take some time, but once you’re there, the calculations are quick. The same can’t be said for many accounting analysis tools.
2 disadvantages of using the cost volume profit analysis
Not all is sunny in CVP land, however. Take a look at these detractors.
1. You need to use precise costs
The CVP analysis has no value without reliable cost data.
Say you estimate that your variable costs are $50 per unit. After running a CVP analysis, you’re satisfied that a $100 selling price will yield you the profits you desire.
Later, you find out that the actual variable cost per unit is $60, significantly cutting into your profit. Your business could be on a much worse trajectory because of an inaccurate CVP analysis input.
2. It doesn’t work for job costing
Businesses that use job costing can’t take advantage of CVP analysis. Manufacturers of unique goods, like furniture and other bespoke items, can’t apply consistent selling prices and variable costs to entire product lines.
You’re a VIP of CVP
CVP analysis is just one of many tools your business can exploit to understand your business better. I recommend looking at our guide to measuring profitability for your next lesson.
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Cost Volume Profit (CVP) Analysis
Cost volume profit (CVP) analysis is a tool that helps business owners understand the relationship between costs, sales volume, selling prices, and profits. It is a type of breakeven analysis that reveals how many units of a product need to be sold to cover costs or meet a profit target. CVP analysis allows businesses to make informed decisions about pricing, production levels, and profit goals. By plugging projected sales numbers into the CVP equation, businesses can explore different scenarios and understand how changes in costs and sales affect their bottom line.
Formulas in CVP Analysis
CVP analysis involves several formulas that provide insights into different aspects of the business. Here are the key formulas used in CVP analysis:

BreakEven Sales Volume ($):
 Formula: Fixed Costs ($) ÷ Contribution Margin Ratio (%)
 This formula calculates the amount of revenue needed to cover fixed costs and break even.

BreakEven Sales Volume (units):
 Formula: Fixed Costs ($) ÷ Unit Contribution Margin
 This formula calculates the number of units that need to be sold to cover fixed costs and break even.

Target Sales Volume ($):
 Formula: (Fixed Costs [$] + Profit Target [$]) ÷ Contribution Margin Ratio (%)
 This formula calculates the amount of revenue needed to cover fixed costs and achieve a specific profit target.

Target Sales Volume (units):
 Formula: (Fixed Costs [$] + Profit Target [$]) ÷ Unit Contribution Margin
 This formula calculates the number of units that need to be sold to cover fixed costs and achieve a specific profit target.
These formulas help businesses determine the sales volume or revenue required to break even or achieve a desired profit target.
Steps to Perform a CVP Analysis
To perform a CVP analysis, follow these steps:

Sum fixed costs: Identify and tally all the fixed costs incurred by the business, such as rent, insurance, salaries, marketing, and depreciation.

Determine the product's selling price: Assess the target selling price for the product based on market research and desired profit margins.

Calculate the variable cost per unit: Determine the variable costs associated with producing each unit of the product, including direct material, direct labor, and variable manufacturing overhead.

Calculate the unit contribution margin and contribution margin ratio: Subtract the variable cost per unit from the unit selling price to obtain the unit contribution margin. Divide the unit contribution margin by the unit selling price to calculate the contribution margin ratio.

Complete the CVP analysis: Use the formulas mentioned earlier to calculate the breakeven sales volume or target sales volume in terms of revenue and units.
By following these steps, businesses can gain insights into their costs, pricing, and profit goals, helping them make informed decisions .
Advantages of CVP Analysis
CVP analysis offers several advantages for businesses:

Breaks down costs: CVP analysis helps businesses think about their product costs in a new way by categorizing expenses into fixed and variable components. This breakdown highlights that not all costs increase proportionally with production, allowing businesses to better understand their cost structure.

Quick and insightful: Once the necessary information is gathered, CVP analysis calculations are quick and provide valuable insights into the relationship between costs, sales volume, and profits. It allows businesses to evaluate different scenarios and make informed decisions efficiently.
Disadvantages of CVP Analysis
While CVP analysis can be a valuable tool, it also has some limitations:

Reliable cost data required: CVP analysis relies on accurate and reliable cost data. If the estimated costs used in the analysis are not precise, the results may be misleading and impact the business's profitability.

Not suitable for job costing: CVP analysis is most applicable to businesses with consistent selling prices and variable costs across their product lines. It may not be suitable for businesses that use job costing, where each product or project has unique costs and pricing.
CVP analysis is just one of many tools available to businesses to understand their costs, pricing, and profit goals. It provides valuable insights and helps businesses make informed decisions, but it should be used in conjunction with other financial analysis methods for a comprehensive understanding of the business's financial health.
I hope this information helps you understand the concepts used in the article. If you have any further questions or need more information, feel free to ask!