Cost Volume Profit also referred to as CVP analysis or break even analysis is part of most feasibility studies for new projects or investments. It is the analysis of the costs of production and volume of units sold in relation to the revenues or profits from a project or investment. All business students will encounter the Cost Volume Profit/CVP analysis or break even analysis both at the graduate and undergraduate levels. Please call us or email us if we can tutor you on CVP analysis or break even analysis.
Break Even Point Definition
The break even point is the point at which revenues of a project or product equals the total costs associated with the sale of the product. The total cost of the project includes the fixed costs and variable costs.
The break even point can be given in units sold or revenues achieved.
Break Even Point Analysis
The primary objective of the cost volume profit analysis is to identify the break even point on a project or investment. It is after determining the break-even point that we can decide if a project is feasible.
Break Even Point Formula
There are two ways to arrive at the break-even point. You can arrive at it from the units sold or from the revenues achieved.
Break Even Point Formula for Units Sold
Break Even Point = Fixed costs / Contribution Margin per unit
Break Even Point Formula in Revenues
Break Even Point = Fixed costs / Contribution Margin as a % of revenues
Contribution Margin
You would have noticed the term ‘contribution margin’ in the break even point formulas. This is a very specific term used in break even point and CVP analysis. The contribution margin is the amount contributed towards fixed costs and profits on every sale. Just like you can think of the break even point in two ways, you can look at the contribution margin in two ways 1) contribution margin in dollars and 2) contribution margin as a percentage of revenues. The formula for contribution margin is:
$ Contribution margin = Revenues per unit – Variable cost per unit
OR
Contribution margin in % = (Revenues per unit – Variable cost per unit) / Revenues per unit
Margin of Safety
The term margin of safety is a term often associated with and popularized by Warren Buffet. However, Warren Buffet used this term from an investment perspective to show how much higher the value of an asset was in relation to the price of the asset. In the world of accounting and corporate finance, the margin of safety means something else. Here the margin of safety is the amount by which revenues exceed the break-even point at different levels of operations.
Present Value Break Even Point
Corporate finance students are very sensitive to the time value of money and the timing of cash flows. Accounting students may not be too concerned with the time value of money and may use the initial investments as the fixed costs in the formulas above. But the finance students will want to acknowledge the timing of the cash flows and so substitute the Equivalent Annual Cost (EAC) of the project in place of the fixed costs in the above formulas. The Equivalent Annual Cost (EAC) is arrived at by dividing the initial investment by the annuity factor of the life of the project. Say the project is a 7 year project, the Equivalent Annual Cost (EAC) is arrived at as follows:
Equivalent Annual Cost (EAC) = Initial investment / 7-year annuity factor
MBA, CPA and CFA students will encounter cost volume profit or break even point analysis in either accounting or finance courses early into the program. Our finance tutors can tutor you on Cost-Volume-Profit or break even analysis and topics related to break even analysis. Please call us or email us if we can assist you.