et 104 cvp analysis

COST-VOLUME-PROFIT ANALYSIS

Essentials of CVP Analysis

Cost-volume-profit (CVP) analysis examines the behavior of total revenues, total costs, and operating income as changes occur in the units sold, the selling price, the variable cost per unit, or the fixed costs of a product.


Illustrative case:Mary Frost is considering selling Do-All Software,

a home-office software package, at a computer convention in Chicago. Mary knows she can purchase this software from a computer software wholesaler at $120 per package, with the privilege of returning all unsold packages and receiving a full $120 refund per package. She also knows that she would pay $2,000 to Computer Conventions, Inc. for the booth rental at the convention. She will incur no other costs. She must decide whether she should rent a booth.


1. Identify the problem and uncertainties.

uncertainties:

selling price ?

number of packages she can sell ?

booth rental ?


2. Obtain information.

attendees to the convention

competitors at the convention

past experiences on selling


3. Make predictions about the future.

Selling price can be at $200 per software

Estimated units to be sold 30-60

Consider competitors in the upcoming

convention

Review predictions, retest assumptions

Establish confidence on the predictions

Consult a friend in the same line of business


4. Make decisions by choosing among alternatives.

identify fixed costs

booth rental $2000

identify variable costs

cost of software package $120


Calculation of operating income at different assumptions:

Contribution margin – difference between total revenues and total variable costs

@ 5 packages

@ 40 packages

Revenues 200 1,000 8,000

Variable cost 120 600 4,800

Fixed cost 2,000 2,000

Operating Income (1,600) 1,200


5. Implement the decision, evaluate performance, and learn.

compare actual with predicted performance

feedback will help future decisions about renting booths at subsequent conventions

et 104 cvp analysis

Technology