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Management 122
Michael Williams
Cost-Volume-Profit
This is an analytical approach used to
model a firms activities.
It involves simplifying assumptions,
specifically that all costs are fixed or
variable.
It can be useful for making a variety of
business decisions.
The nicest feature of CVP is its linearity,
making the math very easy.
Profit
The main objective of any company is to maximize its
profit.
Profit () = Revenue Cost.
Revenue = Price (P) x Volume (V).
Cost = Var. cost/unit (C) x V + Fixed cost (F)
= PV (CV + F).
= (P C) V F.
Contribution margin
The contribution margin is the first part of the profit
equation.
Contribution margin = (P C) V.
This is how much the volume contributes towards the
profit of the company.
Contribution margin per unit (M) is P C. This is how
much profit increases if you increase volume by one unit.
= MV F.
CVP analysis
= MV F
CVP example
Ralphs is considering a new store location. It
expects fixed costs to be $2m / year and average
contribution margin per customer to be $10. How
many customers must Ralphs anticipate, for the
new store to break even?
V = F / M = $2 m / $10 = 200,000 per year.
What if Ralphs requires a $500,000 profit each year?
V = ( + F) / M = $2.5 m / $10 = 250,000.