Cost-volume-profit (CVP) analysis is the study of the effects of changes in costs and volume on a company’s profits. CVP analysis is important in profit planning. It also is a critical factor in such management decisions as setting selling prices, determining product mix, and maximizing use of production facilities.
The following assumptions underlie each CVP analysis.
- The behavior of both costs and revenues is linear throughout the relevant range of the activity index.
- Costs can be classified accurately as either variable or fixed.
- Changes in activity are the only factors that affect costs.
- All units produced are sold.
- When more than one type of product is sold, the sales mix will remain constant. That is, that percentage that each product represents of total sales will stay the same. Sales mix complicates CVP analysis because different cost relationships.
When these assumptions are not valid, the CVP analysis may be inaccurate.