CVP, or cost-volume-profit, analysis is a valuable tool to determine how the company’s profits will be affected by specific decisions. As such, the income statement that it produces can be highly beneficial for the management in its decision-making. It separates costs into variable and fixed, which can help a business make decisions regarding the adjustment of its production.
Heitger, Mowen, and Hansen highlight the contribution margin, which is the difference between the company’s sales and its variable expenses and can be used for the entire unit volume and a singular unit. Through its use, the management can see how increasing or reducing production would affect its income and profits. With that said, it is necessary to consider that production costs are not necessarily linear, especially when the company works with particularly low or high volumes. CVP income statements cannot necessarily accommodate this possibility, and therefore, it is best to use them when considering smaller changes.
One particularly useful application of CVP is the calculation of the break-even point, which is the equilibrium where the business is neither making nor losing money. It determines the lowest production level at which the company can operate to remain sustainable, at least in the short term.
The break-even point in units can be found by dividing the fixed costs by the contribution margin, thus finding how many items would have to be made and sold to compensate for them. As a result, companies that are struggling financially or planning to launch a new venture can attain an understanding of the measures they will need to take to stabilize the enterprise. Hence, the CVP income statement is more useful to internal management than external users, which are provided with the traditional version.