To illustrate the purpose of cost-volume-profit CVP analysis let's get back to our imaginary start-up Friends Corporation, a valves producer.

When you and your friend were thinking of setting up the business, you were probably eager to have answers to the following questions:

• What level of sales is necessary to at least cover all expenses?
• How many valves should be sold in order to earn a planned profit?
• What will happen to profit if we change the selling prices?
• How will changes in variable costs or fixed costs impact planned profits?
• What valve types should we produce and sell more to gain the maximum profit?

Using CVP analysis, we can answer these questions. So what is CVP analysis exactly?

Cost-volume-profit (CVP) analysis helps determine how changes in costs and volume affect a company's profit.

CVP analysis may be helpful for the following tasks:

1. To forecast profit by considering relationship between cost and profit on one hand, and production volume on the other
2. To prepare a flexible budget showing costs at different levels of production
3. To help evaluate a start up operation
4. To evaluate performance for the purpose of benchmarking and control
5. To set pricing policies by projecting the effect of different price structures on cost and profit.

CVP analysis requires certain information to be available before analysis can be performed. The information needed in CVP analysis is as follows:

• amounts of variable and fixed costs
• sales price per unit
• desired level of profit (or loss)

Two techniques are used in CVP analysis. They are equation technique and contribution margin technique. We will review them separately. Also note that CVP analysis can be applied to a single product or multiple products scenarios.