Cost volume profit analysis (CVP) is the model used to analyses the behavior of net income in response to changes in total revenue, total cost, or both.
The cost volume profit (CVP) analysis model depend on understanding the effects of cost behavior on profit, and identify only the relevant relationship.
The following assumptions identify relevant information required to complete a cost volume profit analysis:
- All cost behavior are linear (straight line) within the relevant volume range;
- The sales price per unit, variable cost per unit, and total fixed cost and sales (or production) volume are known. Management information system (MIS) provide all of these information;
- Either the product sold or the product mix remain constant, although the volume changes;
- All revenue and costs can be calculated and compared without considering time value of money;
- All costs are classified as either fixed cost or variable costs. All mixed costs are broken into their respective fixed and variable components. The fixed cost include both manufacturing and non manufacturing fixed cost. The total variable cost include both manufacturing and non manufacturing variable costs;
- Changes in sales volume and production (or purchase) volume are identical (purchase volume would apply to merchandiser). The ending balance in all inventories are zero. Everything purchased is used in production; everything produced is sold. For merchandiser, the sales volume of finished goods purchased for resale is identical to sales volume sold.