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Cost Volume Profit Analysis (CVP)

Are you looking for new ways to track profits and boost your income? Leveraging Cost Volume Profit Analysis can help you achieve this. It determines the best way to price your products and calculates how much volume you need to break even or make a profit. Let’s discuss what CVP analysis is and how you can use it to improve your business.

What Is the Cost Volume Profit Analysis?

Financial professionals often refer to CVP as the break-even analysis. That’s because most managers use the CVP calculation to determine the bare minimum a business needs to make to cover production costs. Managers can use this to either determine optimal pricing, optimal sales, or both. However, the break-even analysis is just one component of knowing how to do CVP analysis.

What Are the Main Factors Affecting CVP Calculations?

When completing an analysis, financial professionals consider four main factors. Take a look at how each one affects the final numbers.

  • Total Fixed Cost: This cost that does not change, no matter how much you produce. Your office lease is an example.
  • Total Variable Cost Per Unit: This cost changes based on production. For example, your variable cost might be $0.50 per widget.
  • Price Per Unit: This is the amount you expect to charge for each item sold. Usually, it refers to the average price and accounts for discounts and allowances.
  • Activity Level: This refers to the number of units sold in the predetermined period. For example, you might sell 100 widgets in a month.

What Are the Main Components of the Cost Volume Analysis Formula?

The CVP formula is easier to understand when you break it down into its main components. These have their own formulas as well, but they are all easy to calculate.

Break-Even Point

Knowing the break-even point sets a base for companies to aspire to and beyond, especially during the early stages. That’s because it often takes new businesses years before they start to generate a profit.

BEP = Fixed Costs / (Price – Variable Costs)

Margin of Safety

This calculates how much “wiggle room” a company has. In other words, it’s the number of units you can sell below the break-even point without incurring a loss.

Margin of Safety = Actual Sales – Break-even Sales

CM Ratio and Variable Expense Ratio

The CM ratio tells you the percentage of each sales dollar that’s available to cover fixed costs. The variable expense ratio, on the other hand, is the percentage of each sales dollar that goes towards variable costs.

CM Ratio = Contribution Margin / Sales

Variable Expense Ratio = Total Variable Costs / Sales

Changes in Net Income

As a business owner, you might also need to quantify changes in your income based on changes in sales. To do this, use the formula below:

No. of units = (Fixed Costs + Target Profit) / CM Ratio

Degree of Operating Leverage

This measures how much your net income changes in response to a change in sales. You calculate it using the following formula:

Degree of Operating Leverage = CM / Net Income

What Are Some Best Practices for CVP Management?

How well CVP benefits your business will come down to whether you follow best practices. These are some of the most common ones managers turn to:

  • Using activity-based costing to create more accurate cost estimates
  • Using relevant range analysis to ensure prices are profitable
  • Understanding the breakeven point and using it to set sales goals
  • Forecasting future changes in costs, prices, and activity levels to stay ahead of the competition and market changes

How Can Account Receivables Automation Assist With CVP?

CVP calculations generate a hypothetical scenario. For example, if an auto parts company sells 400 items, it breaks even. However, the company might not receive full payment. Accounts receivable automation helps companies realize the estimates generated by the CVP analysis.

Those that are familiar with the workforce management space need no introduction to Monday.com and its powerful work OS tool. Monday.com recently moved to an automated accounts receivable (A/R) collection system, powered by Gaviti, to replace its outdated annual reporting methodology.

From Monday.com’s accounts receivables department:

With our business and sales growing exponentially, Gaviti has been a key tool in ensuring our DSO has not only stopped increasing but also shown improvements over a relatively short period of time. The ease of use combined with a highly responsive and helpful team… We have been able to quickly implement a comprehensive and versatile collections process.

When you stop to consider the broader, organizational benefits of automated A/R solutions, it’s easy to understand why Monday.com was so successful. The right A/R collection software can improve cash flow as well as the performance of key metrics – such as days sales outstanding (DSO) – within your organization.

Improve DSO Collection Processes

At its core, DSO collection is a cash flow problem. According to a U.S. Bank study, 82% of businesses fail due to poor cash flow management.

Part of this issue is attributable to the time-consuming processes inherent in manual collections. DSO collections and cash flow already vary from month to month. When you add the time spent managing spreadsheets across late payments, grace periods, and lines of credit, you have an untenable system where staff spends more time corralling reports than processing payments. And while you may not enjoy managing the nitty-gritty details of your business’s finances, your financial processes are ripe for optimization. Consider just a few ways that accounts receivable collection software can streamline your enterprise DSO:

  • Collect on accounts when they’re due with automated customer reminders
  • Create a single source of truth with a centralized A/R database that eliminates the need for tracking/compiling across different spreadsheets
  • Faster invoicing through the elimination of unnecessary payment delays
  • Standardize your process for consistent, repeatable collections every time
  • Streamline payment collection for clients, decreasing the odds of entry errors and making it more likely you’ll get paid on time

When you work to improve your accounts receivable collection, you’re working toward a healthy financial process where DSO stays low. But that’s not the only benefit of an A/R collection solution.

Stay Informed

5 Benefits of Automated Accounts Receivable Collection

In any discussion about the benefits of accounts receivable automation, it’s important to cover the broader benefits it provides:

  1. Better staff efficiency by reducing the manual hours required to perform collections tasks – all those hours you spend chasing invoices, calling clients, or writing follow-up emails add up.

  2. Ensure your data’s accuracy – real-time accurate data will prevent your company from making errors.

     

The benefits of the accounts receivable collection software are clear, and once you’ve deployed
automation,
you’ll have a hard time going back.

A/R Collections Best Practices

Although automated accounts receivable software brings a new dimension to your financial processes, the fundamentals of accounts receivable best practices remain the same. It’s a straightforward process that nevertheless tends to get bogged down by inefficiency. This is where automation software pays off.

Consider how you can leverage financial technology like this throughout your organization to improve key financial metrics. Technology is one option. Outsourcing accounts receivable collections to a service provider that can handle all the details for you is another. You have plenty of options, and now it’s just a matter of selecting which improvements will yield the best results for your enterprise.

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