Better Business Management

The basic components in a cost-volume-profit analysis are the level of activity, unit selling price, variable cost of the unit, the total fixed cost and the income from sales (Axia College, week 5 reading, 2008).

The level of activity is how busy or slow a company is, which affects its total costs and profits. The busier a company is, the higher the total cost of operations will be, but the total profit will be larger because of the increased sales. The unit selling price is the amount of money that each item is sold for, whether it is wholesale or retail. The variable cost of each unit remains constant, no matter what the level of activity is. The total variable cost, however, fluctuates up and down with the activity level. The total fixed cost remains the same no matter what the level of activity is, but the total fixed cost per unit changes. The busier the company is, the lower the fixed cost per unit is. The income from the sales is the amount of money collected from each and every unit that is sold. These five components work together to form an accurate and useable analysis that will help the company's manager make informed decisions.

The contribution margin of a company is the amount of money left after deducting all of the variable costs incurred by the given activity (Moles & Terry, 1997). In other words, the amount of funds left over to pay for fixed expenses and then what is left over as profit. The contribution margin of a unit would increase if the unit selling cost increased, and the margin would go down if the selling cost went down. For example, using my e-Book auctions, if the selling cost of an e-Book increased by one dollar, for a total of three dollars, my contribution margin would raise to $2.40 per unit instead of a mere $1.60 per unit. This is figured out by the unit selling cost ($3.00) minus the unit variable cost ($.60) equals the contribution margin ($2.40).

If the fixed cost of a company goes down, then the sales are affected by the profit per unit increasing. For example, if the monthly fixed cost of my e-Book business went down by sixty cents per book, then the contribution margin would go up, as well as the profit per unit. This can be shown by contribution amount ($2.40 X 20 = $48) minus the fixed cost ($.07 X 20 = $1.40) which equals a profit of $46.60 rather than the original amount of $46.00 ($48 - $2 = $46.00). So a decrease in fixed cost means an increase in profits due to the increase of the contribution margin per unit increasing.

The contribution margins ratio, which some managers prefer, is the contribution margin expressed as a percentage, which aids in judging how profitably a specific item is (Law & Owe, 1999). This percentage basically shows the manager or owner if a certain item or service within their business is worth keeping, or whether they should consider cutting that particular area and replace it with something that yields a higher profit. This ratio is formulated by dividing the contribution margin per unit by the unit selling price. For example, using the numbers from my e-Book business; $2.40 ÷ $3.00 = .8 (80%). The contribution margin ratio can increase or decrease depending upon costs and sales. For instance, if the total sales increased, or if the costs decreased, then the contribution margin would increase.

The cost, volume, and profit analysis is an important tool used by managers and owners to evaluate how well a certain unit, service or item, does within their business. They can use all this information to decide what is providing a profit, and what is not. In this way, managers can make appropriate changes to their company's production procedures to increase their profit margins.

Axia College Cost-Volumn-Profit Relationships Axia College of Phoenix University
Law and Owe A Dictionary of Accounting Axia College Library of Phoenix University
Moles and Nicholas The Handbook of International Financial Terms Axia College Library