Cost-volume-profit (CVP) analysis is used to determine how changes in costs and volume affect a company's operating income and net income. As an entrepreneur, your goal in creating a new business is to satisfy a set of customers profitably and to sell enough goods or services to satisfy your ongoing fixed costs as well as recover your initial investment. Cost-volume-profit analysis is critical for an entrepreneur to use when starting a new business. Through cost-volume-profit analysis, an entrepreneur can set prices, determine if he or she wants to add another product line, or see if the company is spending too much producing its products. Cost-Volume-Profit (or "CVP") analysis is a way to understand a business opportunity in simplified ...view middle of the document...
This analysis is used to determine the break-even point of the business in addition to provides a great help to managers and other business professionals to make short term economic decisions. CVP analysis provides managers with the advantage of being able to answer specific realistic questions needed in business analysis. However, a good understanding of variable and fixed costs provides the organization with a clear view of how it can make a profit using CVP analysis. The basic CVP concept is that the difference or margin between sales and variable cost must first be used to cover fixed costs. Once the organization achieves that breakeven point, then the remaining margin becomes profit. Questions such as what the company's breakeven point is help managers project how future spending and production will contribute to the success or failure of the company. For instance, when a manager knows the breakeven point, he can twist spending and increase production efforts to increase profitability. Because CVP analysis is based on statistical models, decisions can be broken down into probabilities that help with the decision-making process. Although, if manager did not set up or establish the break-even point business plays the risk to suffer financial failure.
Advantages and disadvantages of CVP Analysis
How It Useful tool to Entrepreneur