Question

Explain the basic components of cost-volume-profit (CVP) analysis. Why is it important to determine a company's break-even point?

Answer 1

Basic components of cost volume profit analysis:

1) Level of activity (Number of units sold): Depending on the number of units sold, desired profit to be earned, total cost for breakeven point can be calculated.

2) Selling price per unit: The price for which the product are sold during a given period.

3) Variable cost per unit: Variable cost per unit always remains same. If more units are produced, the variable cost will be more and vice versa.

4) Total fixed cost: Total fixed cost always remains same. Total fixed cost per unit changes with the number of units sold. If more units are sold, the fixed cost per unit will be less and vice versa. With Total fixed cost, breakeven point can be determined.

5) Sales mix: The concept of sales mix arises only when two or more products are sold. In simple terms, sales mix means how many units of each product sold.

It is important to determine a companies breakeven point because, breakeven point is that level of activity where every cost incurred by the company is earned. At breakeven point total revenue is equal to total cost. Total cost means total variable cost and total fixed cost.