Question

A cost-volume-profit graph is frequently used in business meetings because it presents a picture of cost relationships within a company. Briefly describe the type of information and data that you would need in order to prepare a CVP graph. After a CVP graph is prepared, what are the major points that could be made from the graph that would be of interest to management?

Answer 1

The purpose of making a CVP graph is to help a company determine the impact that a change in sales volumes has on cost and profits.

It is necessary to make certain assumptions when preparing a CVP graph:

• Fixed costs remain constant regardless of the level of production.
• The company is able to sell each unit that it produces.
• The selling price of each unit is the same.
• Each additional unit of production results in the same increase in variable costs.

One of the key benefits that a CVP graph provides is that it tells a company about its breakeven point. This allows a firm to plan its production and sales activities.

The CVP graph also puts costs into focus. It highlights fixed costs as well as variable costs.

Example of CVP Graph

The following CVP graph represents Zephyr Corporation’s costs and production levels:

$90,000 $80,000 $70,000 $60,000 $50,000 $40,000 $30,000 $20,000 $10,000 $0 100 300 400 200 Units

The vertical axis denotes dollar amounts and the horizontal axis represents units of production.

The thick green line at the $10,000 level represents fixed costs. This does not change with the level of production. It remains constant at $10,000 even if there is no production.

The blue line is the total cost line. When there is zero production, total costs are at $10,000. The total costs gradually rise with the increase in production.

The yellow line represents sales. At a 100 units of production, when total costs are at $30,000, breakeven is achieved. After this point, Zephyr starts making profits.

• Managers frequently use CVP to estimate the level of sales that will allow the company to make a particular profit, called targeted income. They add the targeted income to fixed costs associated with production, then divide the total by the contribution margin ratio. Alternatively, they divide the total by the contribution margin per unit, to learn how many units they must sell. Using CVP, managers can also estimate how changes in the costs of their products or volume of products affect the company's profits.