 In this presentation, we will discuss cost volume profit analysis or CVP analysis. First question we're going to have is, why use cost volume profit analysis? What is cost volume? Support accounting instruction by clicking the link below giving you a free month membership to all of the content on our website broken out by category further broken out by course. Each course then organized in a logical reasonable fashion making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Cost volume profit analysis, CVP analysis. First we want to remember that this is a managerial accounting topic. So when thinking about financial accounting, we typically will not hear the term CVP cost volume profit analysis. We're not applying rules such as generally accepted accounting principles here and therefore we're not required in any way to have a cost volume profit analysis as CVP analysis. Why then would we do it? It's for decision making processes. It's for internal processes. It's for managerial accounting. One of the major benefits that a cost volume profit analysis will provide our planning tools. When we break things up into a cost volume profit, a CVP analysis type of setup, we have a much easier setup to run scenarios, to run plans, to run projections, to look out into the future and think about what could happen. Now you might think isn't that just what the financial statements are for? What about the normal income statement? Isn't that supposed to measure performance, show performance and help us to make decisions in the future? And the answer is yes, the financial statements do do that, but there are some limitations in terms of forecasting. So remember when we think of a normal type of financial statement, the income statement is usually what we're going to consider when we're considering performance. Those are the timing accounts. Those are the accounts that are determining how we did over time. In essence, revenue minus expenses. How much revenue did we have and how many expenses do we have to incur in order to help us to generate that revenue, given us that bottom line number, that net income. The difference usually is where we categorize the costs. When we think about a normal type of income statement, we want to think about that income statement from the perspective usually of an outside user. Now again, that doesn't mean that an inside user of managerial accountant doesn't take this same information, but note that when we think about generally accepted accounting principles, remember we're thinking mainly about the outside user. The outside user wants to see what really happened over the last year and they want to see the big picture view of that so that they can make investment decisions. And therefore the grouping of the expenses are going to be in alignment with that objective. So we have the revenue and then the expenses is what we're considering. We're considering here a manufacturing type of company usually broken out into cost of goods sold, those things related to what we are selling. That's a category type of grouping or grouping anything that is related to the selling. Remember that if we make things, we're talking about direct materials, direct wages, overhead, a lot of things are going to go into that cost of goods sold number. As we consider it, the different, the behavior of those costs will be much different, but we want to group them in this category by what they do, what do they do, they're there as part of the inventory that we used in order to sell to help generate the revenue. That's how we're grouping the expense that gives us the gross profit. And then we have the other types of expenses, including the operating expenses of selling expenses and administrative expenses. Now again, these administrative and selling expenses are in terms of what types of things they are for, they're clearly for selling and administrative and that's going to be there grouped by their function. They're not grouped by the behavior or how the costs act. And therefore when we get to the net income then of course the net income is the gross profit minus the operating expenses that gives us our net income in a normal type of income statement for a manufacturing type of company. This gives a great summary of what has happened. It does so based on the groupings of why we made these expenses in terms of what it's doing for us to help us to achieve the goal of revenue generation. The problem is if we look out into the future and we start to run scenarios and say, well what if we sell more stuff? What if we sell less stuff? It's more difficult for us to run through this entire type of income statement in a budgeted type of income statement in different scenario settings because the things that are involved in these different categories act differently as production level as the volume of production increases and decreases. So for example in Cost of Good Sold we might have the wages could increase to some degree by the people that are working hourly. It might go up with each level of production but we might have some people that are salary too and their wages aren't going to do anything if we go up in terms of the amount that we produce. And therefore if we were to increase production and think about, well what would happen if we sold this many units next year or this many units and we had a set of increasing number of units that we could possibly sell and we want to just run a bunch of projections on that. It would be difficult for us to do that if we group costs this way by what they're for rather than the behavior of how they act because then we're going to have to go into these and say okay well how is that going to increase or decrease wages and it's difficult to know that because of the structure. So that's going to be leading us to the idea of grouping costs by behavior. What we want to know is that if we sell for example coffee cups if there's an increase in the number of coffee cups what's going to be the increase in net income. To do that we need to structure our income statement differently or at least to do that a lot more easily. We can structure our income statement differently. Another common question for managerial accounting is if we're thinking about the rent or the fixed cost let's say the rent if we want to know how many units we have to sell in order to pay the rent words how many number of units must we sell in order to cover the fixed cost of the rent. These are types of questions we consider in a CVP type of analysis. How does it work what's the major process that we're going to use in a CVP type of analysis. We're going to take the expenses and we're going to break them up not by what they do we're not going to group them by selling an admin or cost of goods sold but by how they act. So we're going to break up the expenses by how they act. We want to break up all the expenses into two categories fixed costs and variable costs. Let's see all the expenses and break them up into fixed type costs and variable type costs. Now a lot of costs this will be easy for us to do if we think about a salaried employee they typically are going to have a fixed type of cost. We're thinking about the rent the rent is what it is it's going to be fixed no matter how many units that we sell and there's going to be some things that are variable if we're talking about direct materials into our inventory typically as we produce more than it will go up at or standard rate as we increase the level of production. Note however that the CVP analysis does make us or force us to take those types of costs that don't line up specifically into fixed or variable and break them up in some way. So that's going to be one of the problems that we have with a CVP type of analysis. We want to break everything up as if they by their nature behave as fixed or variable type costs not all costs do. We do not which means that we're going to have to make some type of estimates in order to do so and what's going to be the payoff of doing that once we do that then we can make these projections much easier in essence then we want to break our normal type of income statement into a contribution margin type of income statement so we're going to have the same bottom line the same net income but we're going to get there a little bit differently we're going to group things a little bit differently or a lot differently we're not grouping by what these expenses do for us we're grouping by how they behave so in the variable costs for example we have the direct materials we've got the direct wages and the sales commission notice that sales commission is totally totally different than say cost of goods sold which is what the other two items are in in a normal income statement we wouldn't group this way because they are serving different purposes although it's for revenue generation they serve different purposes different categories within that goal but in a contribution margin we group them in this format because they behave similar and that will help us with projections as we'll see that'll give us the total variable costs then we'll click the revenue minus the total variable costs we call that the contribution margin again you'll never see a contribution margin in generally accepted accounting principles it's not in a normal income statement you're probably considering about this stage in the income statement is something called gross profit on a normal income statement revenue minus cost to get sold sales minus cost to get sold that is not this number they're not the same at all here because remember variable costs they're by basic they're not by what the costs is for they are by the behavior and then we have the fixed costs these are the costs that don't change with the level of production in our case we got the taxes we got the maintenance on the factory depreciation lease administrative salaries a rent and then the rent on the office as well as the rent on the administrative office those giving us the fixed costs if we subtract out then the contribution margin minus the fixed costs we get the income before taxes then the tax calculation then the net income so again bottom line the same as a standard income statement the approach different as you can see here it doesn't really show you exactly why we would do this yet but when we consider how to think about projections in the future we'll see that this format will be much more useful and easy for us to work with