Discussion on Cost-Volume-Profit Analysis
Ming Chen
School of Economics and Management, Yancheng Institute of Technology, Jiangsu, China
Keywords: Cost-Volume-Profit Analysis, Basic Hypothesis, Limitations of Method, Suggestion of Method.
Abstract: Cost-Volume-Profit Analysis (CVP) is very important for the management of modern enterprises. A common
question in business management is how to use CVP to make decisions. At present, this analysis method is
widely used. It is associated with enterprise risk analysis and can spur the company to strive to reduce business
risk. Combined with the prediction technology, enterprises can make a break-even prediction, profit forecast,
etc., and combine it with decision-making. At first, this paper introduces the viewpoints of CVP at home and
abroad, then briefly introduces this method. After that, this paper expounds the basic assumptions of the
traditional Cost-Volume-Profit Analysis and analyzes its limitations. Finally, this article puts forward some
suggestions to improve this method.
1 INTRODUCTION
Any production and operation activities of an
enterprise will incur costs. In order to pursue
economic benefits, enterprise managers will try their
best to control the costs of operation and production
activities. In addition to simply practicing the concept
of "saving ", current enterprise managers pay more
attention to the benefits brought by the occurrence of
costs to enterprises, that is, "cost effectiveness". Cost
- volume - profit analysis (CVP) is the key to help
enterprises to achieve this "cost - benefit
maximization".
CVP is the abbreviation of cost-volume-profit
relationship analysis. It refers to a method to reveal
the internal regular relationship between variables
such as fixed cost, variable cost, sales volume, unit
price, sales volume and profit with mathematical
accounting model and diagram based on variable cost
calculation mode. At present, CVP is widely used. It
is associated with enterprise risk analysis and can
spur the company to strive to reduce business risk.
Combined with prediction technology, enterprises
can make profit and loss balance prediction and profit
prediction, and combine them with decision-making.
While seeing the advantages of CVP, managers need
to understand and concern its limitations - the
limitations of CVP in product price unchanged,
production and marketing balance and cost division.
2 LITERATURE REVIEW
2.1 Domestic Research Theory
Cost-Volume-Profit Analysis is one of the basic
theories and methods of management accounting. It
was introduced into China in the 1980s and began to
be used in accounting. It can provide effective
information for enterprise cost control and business
decision-making, and has been more and more
applied in China.
Guo Hua pointed out in The Practical Application
of CVP: Through CVP, enterprises can help judge the
safety status of production and operation activities,
grasp the impact of changes in various factors on
profit changes, provide ideas and methods for
enterprises to achieve profit objectives, and control
production and operation activities in a favorable
state (Guo 2011). Ma Xiaofeng put forward in The
Discussion on The Application of CVP in Enterprise
Marketing Management: CVP is directly related to
the balance of revenue and expenditure and profit
level in the enterprise's business activities, so it has a
core position in the enterprise's daily business and
management activities (Ma 2011). Teng Ye pointed
out in The Application of CVP in Enterprises: The
correct use of cost volume profit analysis can
effectively carry out reasonable goal planning for
enterprises, make scientific decisions and correctly
assess the business results of enterprises (Teng 2012).
The effective combination of this analysis method
Chen, M.
Discussion on Cost-Volume-Profit Analysis.
DOI: 10.5220/0011172400003440
In Proceedings of the International Conference on Big Data Economy and Digital Management (BDEDM 2022), pages 233-239
ISBN: 978-989-758-593-7
Copyright
c
2022 by SCITEPRESS – Science and Technology Publications, Lda. All rights reserved
233
and the correct measures of enterprises is conducive
to the development of enterprises in the right
direction. Xue Kaihua proposed in Management
Accounting Analysis Method - CVP: The main
factors of cost volume profit analysis, such as the
change of selling price, fixed cost, variable cost and
business volume, will affect the breakeven point,
which is only the point where the target profit is zero,
while the target profit of the enterprise is often not
zero (Xue 2011). We must discuss the change of the
relationship between cost volume profit under the
change of various factors. Li Pengyu and Niu Yanyan
pointed out in The Analysis of CVP Based on Cash
Flow: In the process of operation, enterprises should
correctly evaluate the reported sales volume and
rationally judge whether they can continue to
maintain production and operation, which should be
based on CVP (Li, Niu, 2013). Li Xiuying, Deng
Xiaolong and Jing Xiling put forward in Management
Accounting: CVP is an analysis method based on cost
behavior analysis and variable cost method to study
the relationship among cost, business volume and
profit (Li, Deng, Jing, 2013). Xin Yun pointed out in
The Application Case Study of CVP Based on
Graphical Model: If CVP is combined with enterprise
decision analysis, it can effectively promote and
support enterprises to make relevant production
decisions and optimal production combination
decisions under factor constraints (Xin 2012). Li
Xiuying, Deng Xiaolong and Jing Xiling put forward
in Management Accounting: The basic assumptions
of CVP are cost behavior hypothesis, relevant scope
hypothesis, constant variety structure hypothesis and
production and marketing balance hypothesis (Li,
Deng, Jing, 2013). Yin Xinhua pointed out in The
Analysis and Application of CVP: The key point of
CVP is the breakeven point (Yin 2014). There are two
ways to express the breakeven point, that is, the sales
volume of breakeven point and the sales volume of
breakeven point. Wu Wanfeng pointed out in On the
Limitations of CVP: In the practical application of
CVP, we should recognize its limitations and cannot
blindly copy the ready-made conclusions of CVP
(Wu 2007). We must study the actual changes of
enterprise operating conditions, market and price,
production factors, variety structure and technology
from a dynamic perspective, and adjust and revise the
analysis conclusions.
2.2 Foreigh Research Theory
As early as 1904, there were written records about the
original cost volume profit relationship diagram in the
United States. In 1922, an accounting professor at
Columbia University put forward a complete
breakeven analysis theory. After the 1950s, CVP has
been widely used in western accounting practice. Its
theory is becoming more and more perfect and has
become an important part of modern management
accounting.
Rajasekaran V mentioned in the book Cost
Accounting that CVP plays an important role in
enterprises. CVP can enable enterprise management
to make more scientific decisions in cost control,
profit prediction, cash flow planning and new
production decisions (Rajasekaran 2010). Theodore
Grossman, John Leslie Livingstone mentioned all
aspects of CVP as a profit planning tool when talking
about cost structure, profit planning and value creation
in The Portable MBA in Finance and Accounting
(Livingstone, Grossman, 2001).
To sum up, CVP has become more widely used in
enterprises, and also for the enterprise the
management, planning, decision-making and so on to
provide beneficial reference, CVP has great role in
enterprises, by the application of various industries, at
the same time, we also want to see some of the
problems of CVP, and then combined with the actual
situation, give full play to the role of the CVP.
3 A COMPREHENSIVE
DESCRIPTION OF CVP
3.1 Implications of CVP
CVP is an analysis of the relationship among cost,
business volume and profit. The premise of using this
method is to use cost behavior analysis, which means
that after studying the cost-output relationship, the
entire cost is divided into fixed and variable costs.
3.2 Basic Formulas of CVP
Operating profit = sales revenue - total cost
= sales revenue - fixed cost
= sales volume * unit price - sales volume
* unit variable cost - fixed cost.
3.3 Basic Application of CVP
CVP can be used for break-even point analysis, profit
point analysis, safety margin analysis, profit planning
and sensitivity analysis. The following sections
provide a brief description of break-even points,
margin of safety analysis, profit points, profit planning
and sensitivity analysis.
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3.3.1 Break-even Point Analysis
a) Analysis in the case of single products.
The break-even point calculation is the simplest
form of cost volume profit analysis when there is only
one product. The sales volume when the firm is in a
position of no profit or loss, i.e. when the net operating
profit is zero, is defined as the break-even point.
Break-even volume = fixed cost / (unit price-
variable cost)
Break-even value = break-even volume * unit
price
= [fixed cost / (unit Price-single
variable cost)] * unit price
The firm can make a profit if its actual sales
volume exceeds its break-even volume (or "the actual
sales value is greater than the break-even value"), the
enterprise can make a profit. Otherwise, the enterprise
will lose money
b) Analysis in the case of multiple products.
In practice, because enterprises' products vary, the
diversification of enterprise products could consider
when calculating the break-even point. In this
instance, the enterprise's break-even point can only be
stated by the break-even amount. There are many
methods to calculate the break-even point, including
comprehensive contribution gross profit rate method,
joint unit method, main variety method, etc. However,
the comprehensive contribution gross profit rate
approach is the most regularly used method by most
businesses. The following calculation formula is used:
Comprehensive break-even value = total fixed cost
/
comprehensive marginal
contribution rate
Weighted average contribution gross profit rate
Sales proportion of a product = value of this product /
total
value
c) Safety margin analysis.
The margin of safety is defined as the difference
between the actual sales value or actual sales volume
and the break-even value or break-even volume. The
margin of safety varies between the absolute and
relative numbers.
Volume of safety margin = actual or expected
sales
volume – break-even volume
Value of safety margin = actual or expected sales
value –
break-even value
Safety margin rate = volume of safety margin /
actual or
expected sales volume * 100%
= value of safety margin / actual or
expected sales value * 100%
The higher the volume/value of the safety margin
and safety margin rate, the higher the safety of profit.
3.3.2 Lucre-safeguarded Point Analysis
Lucre-safeguarded Point is also known as the business
volume to achieve the target profit, divided into lucre-
safeguarded volume and lucre-safeguarded amount.
The basic formulas are:
a) Analysis in the case of single products.
Lucre-safeguarded volume = (fixed cost + target
profit) /
(unit price-unit variable cost)
Lucre-safeguarded amount = lucre-
safeguarded volume *
unit price
= [(fixed cost + target profit) /
(unit price-unit variable cost)] *
unit price
d) Analysis in the case of multiple products.
Comprehensive lucre-safeguarded amount = (total
fixed
cost + target profit) / comprehensive marginal
contribution
rate
3.3.3 Profit Forecast and Profit Planning
The key factors affecting the enterprise's target profit
are unit price, unit variable cost, sales volume, and
fixed cost. To achieve the profit target, enterprises can
take corresponding measures for these four factors,
such as increasing the sales unit price, reducing
variable costs, increasing production and sales,
reducing fixed costs, etc. Furthermore, firms could
also work together to take comprehensive measures to
achieve the profit target.
3.3.4 Sensibility Analysis
Profit is sensitive, and it changes with certain factors.
The investigation of its evolving process is known as
a sensitivity analysis.
The factor that has a large impact on profit and
causes it to fluctuate substantially has a high
sensitivity. On the contrary, it has low sensitivity.
The emphasis of enterprises are different. The
executive should prioritise characteristics with high
Discussion on Cost-Volume-Profit Analysis
235
sensitivity and pay less attention to factors with low
sensitivity.
Managers should determine the sensitivity based
on a detailed understanding of the relationship
between profit and factors and then predict profit.
3.3.5 Short-term Business Decisions
Through CVP, the enterprise can calculate the break-
even point and lucre-safeguarded point and provide an
entirely scientific basis for production and pricing
decisions. For example, whether the company should
develop new products, whether loss products should
continue to be produced, whether the company should
accept low price orders, how to determine the optimal
price and decide the pricing strategy under special
conditions, etc.
3.4 Basic Assumptions of CVP
3.4.1 Cost Trait Division and Assumptions
of Variable Cost Method
The variable cost method is the core of the cost
volume profit analysis method, which premise is to
control the cost behavior analysis (Sun, Wen, Yang,
2012). According to the cost behavior analysis, the
cost is divided into fixed, variable, and mixed costs
(Tu, 1989). And then, the mixed cost is further divided
into fixed cost and variable cost. Finally, the three
major costs are reduced to fixed and variable costs.
Unit product cost = direct labor + direct material +
variable
manufacturing cost
Period expenses = fixed manufacturing fee + sales
expenses
+ management fee + financial expenses
3.4.2 Relevant Range and Linear
Assumptions of Total Cost
CVP posits that, within the relevant range, assuming
the fixed cost and unit variable cost are constant, total
cost and business volume will have a linear
relationship (Teng, Wei, 2012). The formula is
expressed as Y =A + BX. when the unit price remains
constant, the relationship between sales income and
business volume is represented as Y = PX.
3.4.3 Balance between Production and Sales
and Stable Variety Structure
If the proportion of the product revenue in the total
revenue will not change, the breed structure is stable.
However, it is difficult for companies to keep their
proportion constant. When a company changes its
sales structure, the steady structure is disrupted, and
the profit is substantially lower than it was previously.
What is the meaning of balance between
production and sales? It signifies that the enterprise's
sales volume and production volume have reached a
balance. In this case, the volume in CVP refers to the
sales volume. When the sales unit price remains
constant, this figure represents the sales income.
However, sales volume may vary from production,
and as a result, production might affect profitability.
3.4.4 The Assumption That Target Profit is
Operating Net Profit
The reason for assuming that the target profit is the
operating net profit is that under this assumption,
enterprises are allowed to use CVP combined with the
profit-even map to obtain information about the
break-even point, lucre-safeguarded point and so on,
and to carry out safety analysis and sensitivity
analysis.
4 LIMITATION ANALYSIS AND
PRECAUTIONS OF CVP
4.1 Limitation Ananlysis
4.1.1 CVP Has Special Requirements for
Cost Problems
The fixed cost separated from the mixed cost needs to
be integrated into the original fixed cost before
applying the cost volume profit analysis technique,
and the new fixed cost and variable cost need to be
divided from the mixed cost. However, in practice,
we are confused about "how to split the mixed cost".
4.1.2 CVP Assumes That the Total Cost Has
a Linear Relationship with Sales
Volume, and the Sales Revenue Has a
Linear Relationship with Sales Volume
When using CVP, the study analyzes it with the help
of the break-even analysis chart.
Firstly, the cost-and-income line should be a
curve in theory. When using CVP, this study assume
that the fixed cost and unit variable cost remains
constant. However, in practice, the overall cost of
fixed assets cannot remain constant over time, and
variable costs will also be curved as a result of
changes in business scale and production efficiency.
When analyzing sales revenue, the unit price will
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fluctuate under the influence of the market economy,
thus it will be a curve as well.
Secondly, BEP (break-even volume = fixed
cost/unit marginal contribution) has no practical
significance since fixed assets differ significantly
between various types of firms. Therefore, there are
also great differences in break-even point. However,
it is meaningless if the break-even threshold is too
high or too low.
4.1.3 CVP Only Considers "EBIT"
Pre-tax profit, such as total profit, operational profit,
and operating net profit, is referred to as "EBIT." The
quality of analysis results is directly tied to the index
used as the profit in CVP. To be consistent with the
subsequent profit sensitivity analysis, although this
assumption strengthens the relationship between cost,
business volume and profit, it excludes profit-
affecting factors other than the enterprise's
production and operation activities, resulting in the
deviation form target profit. Moreover, policymakers
are concerned about after-tax profits. Therefore, the
key challenge to be solved in CVP is after-tax profit.
4.1.4 CVP Is Carried out under the
Condition That Prices Remain
Unchanged
Price changes have a significant impact on the
success or failure of decision-making. Cost volume
profit analysis follows the historical cost principle,
which impedes the achievement of analysis
objectives, such as information processing
procedures that do not adapt to price changes. Most
businesses have a minimal share of machinery and
equipment in their total assets, and the possibility of
replacement is also limited. The possibility of
replacement of fixed assets such as houses,
inventories and buildings are extremely high. Price
changes affect the cost and inventory of these assets
and the price of the company's products, and the latter
is sometimes more affected by price fluctuations than
the former. Therefore, the sales revenue line and total
cost line on the break-even chart will fluctuate over
time. Moreover, managers can achieve a lower break-
even point if the increase in the cost of each product
is smaller than the increase in the price. Therefore,
increasing sales and profits is of no practical
meaning.
4.1.5 CVP Does Not Consider the Impact of
Simultaneous Changes of Multiple
Factors on the Realization of Target
Profit
The analysis method proves the impact of changes in
quantity, cost and sales price on enterprises, but its
application has certain limitations because it is based
on the following assumptions: Single-product sales;
Sales of various products, although the proportion of
sales of various products remains constant. If the
sales proportion of various products changes, the
break-even point will also change. "All other
variables remain unchanged in quantity" - this is
unrealistic, so that this assumption may be unfeasible.
Increased sales volume, for example, will certainly
result in a decrease in unit variable cost.
4.2 Several Points for Attention in the
Application of CVP
4.2.1 The Total Cost Is Divided into Fixed
Cost and Variable Cost
Before to employing CVP, the cost is separated into
variable and fixed costs based on an examination of
cost behavior. Before employing cost behavior, costs
are classified as variable, fixed, or mixed. When
adopting cost behavior, variable cost is still a variable
cost, and fixed cost is still a fixed cost, according to
cost habit. However, because mixed cost has both
variable cost and fixed cost habits, it must be divided
into variable cost and fixed cost. In terms of how to
decompose, the following strategies are commonly
used:
a) High and low point method.
The cost behavior model is based on the total cost
and business volume, from which the highest and
lowest business volumes are determined, and the total
cost is decomposed to obtain:
Unit variable cost = (maximum business volume
cost –
minimum business volume cost) /
(maximum business volume –
minimum business volume)
Total fixed cost = maximum business volume cost
- unit
variable cost * maximum business
volume
= minimum business volume cost - unit
variable cost * minimum business
volume
b) Regression Analysis.
Discussion on Cost-Volume-Profit Analysis
237
Based on the previous data, the business volume and
mixed cost are analyzed, and the regression line
indicating the link between business volume and the
mixed cost is obtained using the least square principle
to determine the fixed cost and variable cost. The
mixed cost is assumed to conform to the total cost
model, that is, y = a + bx (a is the fixed cost
component; b is the unit variable cost).
c) Account Analysis Method.
The type close to the cost is judged based on the
content of relevant cost accounting and its detailed
accounting, as well as its dependence on production,
and is recognised as the type of cost. This cost's type
can be considered its closest cost type.
d) Technical Measurement Method.
It is a method to divide fixed and variable costs
according to the technical measurement of various
material consumption and labour costs in the
production process.
e) Contract Confirmation Method.
According to the payment provisions in the
agreement signed by the enterprise, confirm which
items belong to variable cost and which items belong
to fixed cost.
While there are several approaches for
decomposing the mix of costs, the approach depends
on the enterprise's specific situation.
4.2.2 Comprehensively Consider the Impact
of Simultaneous Changes of Various
Factors on the Realization of Target
Profits
Various factors affect profits, one of which changes,
and the other follows suit, one of which changes, and
the other follows suit. For example, after lowering the
price, if the sales department believes that the lucre-
safeguarded volume (amount) can be fully realized
and the production department believes that there is
sufficient production capacity, the target profit can be
implemented. However, the sales department
believes it is difficult to realize the lucre-safeguarded
volume (amount), and the volume(amount) cannot be
realized after the price reduction. Thus, cost control
is essential. Therefore, the production department
needs to reduce the unit variable cost. If the
production department believes that reducing
variable costs (such as raw materials and labor
expenses) can assist the firm to achieve the
predetermined profit goal, this method can help the
enterprise achieve the predetermined profit goal.
Otherwise, enterprises also need to save fixed costs.
5 SUGGESTIONS ON
IMPROVING CVP
5.1 Understand Cost Drivers
Cost driver is the factor that leads to cost occurrence
and determines the level of cost occurrence.
According to the relationship between cost and cost
driver, cost can still be divided into variable cost and
fixed cost, but the definitions of variable cost and
fixed cost have changed. Variable cost is a cost that
is proportional to the change of cost drivers. Fixed
costs refer to the costs that do not change with the
changes in cost drivers. Compared with the
simultaneous interpreting models, the following
differences can be seen: Firstly, the variable cost of
each production and marketing unit is different from
the traditional unit variable cost, and the improved
CVP is more accurate. Secondly, different from fixed
costs, some once regarded as fixed costs may change
at any time due to cost drivers unrelated to production
and sales quantities. The results show that the target
production and marketing quantity calculated by the
expanded model is less than that calculated by the
original model. Undoubtedly, the extended model is
more accurate than the original model, and it also has
a significant impact on enterprise planning and
decision-making.
5.2 Combined with Rolling Budget and
Dupont Analysis
Based on the traditional CVP, the advantages of
rolling budget and DuPont analysis method are
absorbed to overcome the disadvantage of the
traditional CVP that "the annual target profit is
determined by the planned variable cost, fixed cost,
quantity and sales price, and the planned control
number of some variables in the later stage is not
adjusted according to the deviation between the
actual amount of the above variables and the planned
value". Adopt quarterly (or monthly) "rolling"
calculation and financial analysis methods such as
DuPont analysis to determine the controlled level of
variables such as variable cost, fixed cost, sales
volume and unit price in the later stage of the
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enterprise in order to achieve the expected profit
target of the enterprise, and take this as the guidance
to urge the enterprise to take measures to "correct
errors", to ensure the completion of the target profit,
so that the CVP can be better used in the process of
pre prediction, in-process analysis and control and
post summary.
6 CONCLUSIONS
CVP is one of the practical technologies of modern
enterprise management. The application research of
cost-volume-profit by enterprises, through the
analysis of the functional relationship between cost,
business volume and profit, helps decision-makers
correctly formulate price policies, marketing policies
and effective cost management, control and
assessment measures, which has important practical
significance and long-term strategic role.
With the deepening of China's openness and
competition, it is more and more necessary for
enterprises to promote the application of CVP. When
applying this method, we should pay attention to its
five assumptions. In decision-making, we should
correctly analyze the basic principle and function of
CVP, avoid wrong decision-making, and understand
the limitations of this method, so as to better play a
role in the business decision-making of enterprises.
As long as enterprises deeply understand, accurately
grasp and flexibly use the essence of this analysis
tool, CVP will bring huge economic benefits to
enterprises.
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