Every business operator needs to constantly keep tabs on profits and losses. But they also have to have more information than the profit-loss statements on annual reports and year-end taxes. They need to know which are their most profitable products or services, what will be the effects of increasing fixed costs, such as a business loan or the purchase of new equipment, and what consequences a drop in sales volume would have.
One of the best tools for answering these and many other business questions is cost/volume/profit analysis . "CVP analysisàis a way of examining the relationship between your fixed and variable costs, your volume (in terms of units or in terms of dollars), and your profits" (www.toolkit.cch.com).
Its three main elements are breakeven analysis (which tells you what sales volume you need to break even in different cost and pricing situations); contribution margin analysis (which allows you to determine the profitability of different products and services); and operating leverage (which looks at the percentage of fixed costs in your business, which varies directly with an increase in sales or losses).
In order to determine your cost/volume/profit relationships, you first must find which costs are fixed (like rent or salaries), and which are variable (such as higher costs based on an increased volume of sales) û although it's important to remember that some costs are a combination of fixed and variable, and that they are fixed only within a certain range of time and activity.
You get the cost per unit by dividing the variable costs and divide by the number of units sold. The contribution margin is the percentage of each sales dollar left after variable costs are subtracted. You can determine your breakeven point after you know your fixed and variable costs.
This information is critically important in deciding whether to add or remove a product, change your pricing structure, or increase fixed c...