CVP (cost-volume-profit) analysis is a cost accounting tool used to examine how profits change as sales volume, prices, and costs changes. CVP is a traditional method of evaluating profitability of a business whereby it only considers unit-level activity cost drivers: sales, costs, and prices (Rajasekaran, 2010). CVP is also a technique, used to evaluate the relationship among total revenues, total costs (both fixed and variable), volume of production, and profits for a specific period.
One of the uses of CVP analysis in a company is determination of the optimal sales prices for a company’s goods and/or services (Rajasekaran, 2010). CVP analysis plays a vital role in formulation of pricing policies of a company, with an aim of allowing the company to reap reasonable profits from sale of its goods and/or services. CVP analysis is also used in companies for planning purposes. Managers use CVP analysis to conduct profit planning whereby they determine profits at different activity levels. Companies also use CVP analysis to forecast profits. This is done through studying the relationship between profits and sales volume, as well as the relationship between profits and costs. This way, a company is able to determine the amount of profits it should expect during a specific period. Moreover, CVP analysis is a helpful decision-making tool. Managers use CVP analysis when making decisions concerning production of new products. The results obtained after comparing the sales volume, costs, price, and expected profits of a given product: CVP analysis, help managers to determine if production of such a product is economically feasible, or not (Rajasekaran, 2010).
On the other hand, break-even point is a point at which gains are equal to losses (Rajasekaran, 2010). This implies that break-even point is the point at which a company’s sales exactly cover all the expenses incurred within a specific period. At this point, no gains or losses are obtained: a company makes enough sales of its goods and/or services to cover all the costs related to the period during which the sales were made, without making a profit or a loss. In order to calculate break-even point of a given product, one needs to obtain three variables: unit price/sales price of a single unit of production, variable costs, and total fixed costs. Variable costs are the costs that change as the level of sales change, while fixed costs are the costs, which do not change with changes in volume of sales. While calculating break-even point of a given product, the fixed costs are stated as a total (all fixed costs of a firm) while variable costs are stated as per unit of production. The formula for calculating break-even point is as follows: Fixed costs/price – Variable costs (FC/P – VC) (Rajasekaran, 2010).
Managers have interests in break-even point of products in their companies because they recognize that for their companies to survive in the long-run, their products’ revenues must be able to meet all the expenditures of their companies. Therefore, attaining a break-even point is the priority of every manager. This implies that a manager has to ensure that his/her company produces a designated number of units, whose sales revenue would be enough to help the company continue its operations (Loughran, 2012).
Contribution margin is the difference between sales and variable expenses (either in total or per unit). On the other hand, fixed costs are the costs, which do not change with the level of production. Examples of fixed costs include depreciation and rent expenses. The relationship between contribution margin and fixed cost is that both of them are important in the determination of break-even point. Contribution margin provides the amount of money that every unit of production contribute towards fixed costs of a business. If the total contribution margin exactly covers, all the fixed cost of a business, then a break-even point is achieved (Rajasekaran, 2010).