Cost volume profit analysis is a method of analyzing the affect of transition of cost and volume on the net income and operating income of a business. It is a method of cost accounting and is used to make short term financial decisions regarding the business. In simplified words cost volume profit analysis is applied by finding out the breakeven point of the cost of goods as compared to the volume of the goods. Cost volume profit analysis makes use of that critical point where the total revenue becomes equal to the total costs.
While doing the cost volume profit analysis a number of assumptions are made by the decision makers such as it is assumed that the sale price per unit volume will remain constant. In addition to that the variable price per unit volume is also considered to be constant. It is assumes that each unit produced is sold by the company that means there is no stock of the units and the total fixed costs of the units produced are also constant.
In order to do a complete cost volume profit analysis mangers must do a price forecasting and understand the fixed costs including depreciation, rent, wages, utilities and other kind of fixed costs. The next step is to determine the variable costs that decrease and increases with volume of goods produced. The next step is to calculate the unit contribution margin ratio that is used with the fixed costs to calculate the breakeven point. After calculating the breakeven point the budgeted profit or loss is estimated and it is learned that every sale after the breakeven point is pure profit.