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CPV analysis is a system used for checking how changes in the volume of production affect the costs and thus the profits. It is an expanded form of break-even analysis, which simply identifies the breakeven point. CVP analysis is somewhat simplified and relies on some assumptions that do not hold in reality, meaning it is best used for simple "big picture" analysis rather than detailed examination.
Breakeven analysis takes account of the fact that production incurs both fixed and variable costs. Fixed costs include machinery, factory real estate and, to some extent, marketing. Variable costs include labor and raw materials; more of these resources are used as more products are made. The break-even point is calculated as the fixed costs divided by the contribution per unit. The contribution per unit is the price the company sells the product at, minus the specific variable costs associated with producing that individual unit.
CVP analysis takes its name from cost, volume and profit. The associated analysis plots two lines on a graph with a horizontal axis that shows the total number of units produced. The two lines represent the total revenue and the total cost for that number of units. In virtually every case, the revenue line will start out higher than the cost line, but go up at a steeper angle and eventually narrow the gap before overtaking the cost line and then widening its lead. This represents increasing sales lowering losses, hitting the breakeven point and then producing increasing profits.
There are several significant limitations to these figures which result from simplified assumptions in the process. One obvious one is that it assumes that every unit produced will automatically be sold. This is often not the case in reality, and the more units that are produced, the greater the risk of being left with unsold stock.
Another problem with CVP analysis is that in reality there is some crossover between fixed and variable costs. For example, the fixed cost of machinery will increase once it is running at full capacity and production is then increased. Meanwhile variable costs don't always vary perfectly in line with the volume of production. A business may be able to increase production without increasing labor costs to the same extent if it is able to pick up some slack in the staff's workload.
CVP analysis also has the limitation that it fails to account for all the ways figures may vary. The sales price is treated as a constant, but in the real world, increased sales may entail some buyers getting a bulk discount. Similarly, the variable cost per unit may not be consistent, for example, if materials can be bought in large quantities at a lower price.
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