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Too
many businesses operate in the dark. Unaware of the impact that basic
decisions have on the rest of their business, they blindly make haphazard
choices and clean up the mess later. Your cost/volume/profit (CVP) analysis
gives you the insight you need to make the right choices and avoid costly
mistakes.
These
are some of the things your CVP analysis can tell you:
-
The
most profitable product or service you offer
-
Which
products or services should be emphasized
-
What
sales volumes you need to meet in order to stay profitable
-
Sales
goals you will need to meet in order to cover any increase in fixed
costs (i.e. an increase in rent)
-
The
increase in sales you’ll need to compensate for any discounting
To
make the most of your CVP analysis, you must first understand your fixed
costs and your variable costs.
Fixed
costs are
those costs that remain the same no matter what volume of sales your
business has.
This
includes rent, insurance, licenses, wages for permanent employees, interest
on loans and operational expenses.
Variable
costs
are directly related to your sales levels in dollars or units sold. For
example, materials and supplies, commissions on sales, sales incentives or
bonuses for employees and shipping costs are all considered variable
costs.
While
your accountant can help you ascertain which of your costs are fixed and
which are variable, you or someone who is very familiar with your business
will need to make the final determination. This can get tricky but to assist
you, here are some further explanations of costs.
Combination
costs. There
may be times when a minimum level of cost will be incurred regardless of
sales levels but the costs rise as your volume increases. You will need to
determine the most important type of cost. For example, you may pay a flat
fee for being able to process credit card purchases and an additional fee
for each charge processed. If the cost of processing each charge is greater
than the monthly flat fee, you would classify this as a variable cost.
Relevant
range of activity. Your
CVP analysis is only relevant or valuable when you consider it within a
range of sales that is reasonably expected for your business. Likewise,
fixed costs only remain fixed over a certain period of time or within a
relevant range of activity. Think about your insurance, it may become more
or less expensive with time. If your CVP parameters are not clearly set in
terms of volume of sales and period of time, your results will not be
useful.
Cost
per unit or job. To
arrive at this number, add up all your variable costs for the designated
accounting period then divide by the number of units sold. Service providers
may want to use the number of jobs or hours spent on the jobs instead of
units sold. The cost per unit or job does not fluctuate and can be useful
when coming up with bids for projects.
Classifying
your costs is critical to coming up with a successful CVP analysis. Your CVP
analysis offers three critical types of information:
-
What
sales volume you need to achieve breakeven? A
breakeven analysis tells you the sales volume you need to reach under
different pricing strategies and cost scenarios so that your business
can breakeven.
-
Which
products or services are the most valuable?
A contribution margin analysis compares your different products and
services and their overall profitability. Using this information, you
can resolve which products to promote strongly and which products you
may want to discontinue.
-
How
your fixed costs impact your bottom line. An
operating leverage report lets you examine the effects of increasing or
decreasing the role of fixed costs in your operating structure.
If
you would like to discuss your CVP Analysis further or would like help with
implementing any of the ideas in this article, please contact our office for
further information.
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