PROFIT ANALYSIS

Profit analysis

Profit is a monetary gain a business produce after saleing products .a profit analysis is a break down of a business applying a monetary amount for each element and performing calculations to determine what profit is.

In the business world profit analysis most often referred to as cost volume profit

(CVP) analysis .

(CVP) Cost profit analysis

in managerial economics is a form of cost accounting . It is a simplified model, useful for elementary instruction and for short-run decisions.

It is a technique that examines changes in profits in response to changes in sales volumes, costs, and prices. Accountants often perform CVP analysis to plan future levels of operating activity and provide

information about :

1 -Which products or services to emphasize2 -The volume of sales needed to achieve a

targeted level of profit 3 -The amount of revenue required to avoid

losses4 -Whether to increase fixed costs

5 -How much to budget for discretionary expenditures

6-Whether fixed costs expose the organization to an unacceptable level of risk

Profit Equation and Contribution Margin

CVP analysis begins with the basic profit equation

. Profit = Total revenue - Total costs

Separating costs into variable and fixed

categories, we express profit as :

Profit = Total revenue - Total variable costs - Total fixed costs

The contribution margin is total revenue

minus total variable costs. Similarly, the contribution margin per unit is the selling price per unit minus the variable cost per unit. Both contribution margin and contribution margin per unit are valuable tools when considering the effects of volume on profit

Contribution margin per unit tells us how much revenue from each unit sold can be applied .toward fixed costs

Once enough units have been sold to coverall fixed costs, then the contribution

margin per unit from all remaining sales becomes profit.

If we assume that the selling price and variable cost per unit are constant, then total revenue

is equal to price times quantity, and total variable cost is variable cost per unit times quantity

We then rewrite the profit equation of the contribution margin per unit

Profit = P * Q - V * Q - F = (P - V ) * Q - Fwhere

P Selling price per unitV Variable cost per unit

(P - V )Contribution margin per unitQ Quantity of product sold (units of goods or

services)F Total fixed costs

We use the profit equation to plan for different volume of operation

CVP analysis can be performed using either: 1 -Units (quantity) of product sold

2 -Revenues (in dollars)CVP Analysis in Units

We begin with the preceding profit equation. Assuming that fixed costs remain constant, we

solve for the expected quantity of goods or services .must be sold to achieve a target level of profit

CVP analysis employs the same basic assumptions as in breakeven analysis. The assumptions underlying CVP analysis are:

The behavior of both costs and revenues is linear throughout the relevant range of activity. (This assumption precludes the concept of volume discounts on either purchased materials or sales.)

cost can be classified accurately as either fixed or variable.

Costs Changes in activity are the only factors that affect costs.

All units produced are sold (there is no ending finished goods inventory).

When a company sells more than one type of product, the sales mix (the ratio of each product to total sales) will remain constant

The components of CVP analysis are:Level or volume of activity

Unit selling pricesVariable cost per unit

Total fixed costsSales mix

Assumptions

CVP assumes the following:Constant sales price;

Constant variable cost per unit;Constant total fixed cost;

Constant sales mix;Units sold equal units produced.

.

These are simplifying, largely linearizing, which are often implicitly assumed in elementary discussions of costs and profits. In more advanced treatments and practice, costs and revenue are nonlinear and the analysis is more complicated, but the intuition afforded by linear CVP remains basic and useful.

One of the main methods of calculating CVP is profit–volume ratio: which is (contribution /sales)*100 = this gives us profit–volume ratio.

contribution stands for sales minus variable costs.

Therefore it gives us the profit added per unit of variable costs

Basic graph

Basic graph of CVP, demonstrating relation of total costs, sales, and profit and loss

The assumptions of the CVP model yield the following linear equations for total cost and total revenue (sales):

These are linear because of the assumptions of constant costs and prices, and there is no distinction between units produced and units sold, as these are assumed to be equal. Note that when such a chart is drawn, the linear CVP model is assumed, often implicitly.

In symbols:

TC=TFC+V.XTR=B.X

whereTC = Total costs

TFC = Total fixed costsV = Unit variable cost (variable cost per unit)

X = Number of unitsTR = S = Total revenue = Sales

P = (Unit) sales priceProfit is computed as TR-TC; it is a profit if positive, a

loss if negative.

Break down even point

Costs and sales can be broken down, which provide further insight into operations.

Decomposing total cost  as fixed cost plus variable cost.

Decomposing sales as contribution plus variable costs

Following a matching principles of matching a portion of sales against variable costs, one can decompose sales as contribution plus variable costs, where contribution is "what's left after deducting variable costs". One can think of contribution as "the marginal contribution of a unit to the profit", or "contribution towards offsetting fixed

costs."In symbols:

whereC = Unit Contribution (Margin)

Profit and loss as contribution minus fixed costsSubtracting variable costs from both costs and

sales yields the simplified diagram and equation for profit and loss.

Diagram relating all quantities in CVP. These diagrams can be related by a rather busy diagram, which demonstrates how if one subtracts variable costs, the sales and total costs

lines shift down to become the contribution and fixed costs lines. Note that the profit and loss for any given number of unit sales is the same, and in particular the break-even point is the same, whether one computes by sales = total costs or as contribution = fixed costs. Mathematically, the contribution graph is obtained from the sales graph by a shear, to be precise , where V are unit variable costs.