Project Profits with Cost-Volume-Profit Analysis | QuickBooks Malaysia

For all Malaysian businesses, the ability to calculate revenue projection is vital for understanding your business finances. It’s also a good indicator of where you’re heading in the future. 

Costs, volumes, and profits are useful in their own right, but when looked at together, they give a much clearer picture of your financial health. 

In this article, we’ll take a look at what CVP analysis is, why it’s important, and how to calculate it.

Understanding cost-volume-profit (CVP) analysis

Let’s dive into what CVP analysis is and how it works: 

What is CVP analysis?

A cost-volume-profit (CVP) analysis is a tool used to examine the relationship between a company’s overall costs, the volume of sales, and the resulting profit.

It’s also known as a break-even analysis. With a CVP analysis, businesses are able to gather information on how many units they need to sell in order to become profitable.

It sounds simple, but it becomes a little more complicated because businesses have to deal with both fixed and variable costs each month. This means that the financial projections you gather from a CVP analysis are closer to educated assumptions rather than cold facts. 

However, if taken as an indication metric, a CVP analysis is a good way of getting a broad picture of where your business is currently at and where it’s heading. 

Key components of CVP analysis

There are several key parts to this formula:

• Fixed costs: These are nice and straightforward. They’re the costs a business incurs each month that aren’t likely to change on a month-by-month basis.
• Variable costs: These are the costs to a business that do change each month .
• Volume of sales: The total number of sales over a given period of a particular product or service.
• Contribution margin: This is the difference between the volume of sales and a company’s variable costs.
• Break-even point: This is the total amount of revenue, or units sold, required once the total costs to a business have been deducted.

Steps to conduct CVP analysis

Now that you know what CVP analysis is, here are the necessary steps to determine how you can calculate your own CVP analysis metrics:

Identify fixed and variable costs

It’s very important that you have these two figures in mind when conducting a CVP analysis over a given period. You can start by creating a list of all your expected business expenses.

If the cost of something doesn’t alter despite changes in production levels, then it’s a fixed cost. These are things such as your office space rent and monthly subscription costs.

If the cost does alter with changes in production levels, they’re considered variable costs. For example, the material cost in the first month might be $500 for 1000 units. However, in the next month, 2000 units are sold, so the material cost would be $1000.

Having a good grasp on these figures is essential for generating financial projections.

Calculate contribution margin

The contribution margin is a key metric to determine whether the pricing of a specific product or service is leading to profit. It’s calculated using the following formula:

Contribution margin (CM) = Revenue (R) - Variable costs (VC) 

We can also calculate the contribution margin ratio (CMR):

Contribution margin ratio (CMR) = (Revenue (R) - Variable costs (VC)) ÷ Revenue (R)

Let’s say that a business is generating a revenue on a sofa of $500. The variable costs to produce this sofa comes in at $400. So the contribution margin ratio would be as follows:

Contribution margin ratio (CMR) = (500 - 400) ÷ 500 = 0.2

We take this 0.2 and turn it into a percentage, giving us a contribution margin ratio of 20%.

There’s no hard and fast rule as to what is considered to be a good contribution margin ratio. However, anything above 50% is typically excellent. So, in the above scenario, the company might need to look into increasing prices, or decreasing their variable costs.

Determining break-even point

With the contribution margin found, we can now calculate the break-even point of a given product using the following formula:

Break-Even Point (BP) = Fixed costs (FC) ÷ Contribution margin (CM)

Let’s use the sofa scenario as an example, the contribution margin would be $100. And let’s say that the fixed costs for the business are $3000:

Break-Even Point (BP) = 3000 ÷ 100 = 30

So in this scenario, the company would need to sell 30 sofas over a given period,say, monthly, in order to break even on that product.

Applying CVP analysis to financial projections

We can take this one step further by using CVP to calculate a revenue projection for any given product or unit.

We’re going to take the above example again, only this time we’re going to use the CMR, and apply the following formula:

Break-Even Point (BP) = Fixed costs (FC) ÷ Contribution margin ratio (CMR)

And once we enter the figures, we get the following:

Break-Even Point (BP) = $3000 ÷ 0.2 = $15,000

This means that the company will need to make a revenue of $15,000 on this sofa product in order to break even.

Profit forecasting

So, what is projected profit? In this particular example, let’s say that the sofa has seen a steady increase in sales over the past few months.

Month #1 = 30 units sold

Month #2 = 36 units sold

Month #3 = 42 units sold

Month #4 = 50 units sold

We’re looking at about a 20% increase each month on sales, so if we anticipate that this trend is likely to continue, the company can expect to sell around 60 units in month #5. The price for each unit remains the same, $500, which means 60 units sold at this price gives us a revenue projection of $30,000.

We already know the break-even point for this particular product is $15,000. So, if we deduct this from the overall anticipated revenue for month #5, we expect this business to make a profit of $15,000 for that month.

Using a combination of your historical sales data trends and CVP analysis can help you determine the anticipated revenue and profit for each product and service you provide.

Tools and resources for CVP analysis

A CVP analysis will be much more challenging without tools to calculate the various metrics that go into it, such as fixed and variable costs, revenue, and units sold. At QuickBooks, we give businesses access to a huge range of such tools, including our expense tracker.

With your expenses accounted for using our easy-to-use software, you can then dive into our detailed financial reporting, which will allow you to make informed decisions on pricing and sales strategies.

The importance of CVP analysis for Malaysian businesses

Sometimes businesses can go a bit over the top when it comes to analysis, data, and metrics. However, there are a number of reasons Malaysian businesses should commit to carrying out CVP analysis:

Strategic decision making

All businesses want to know whether their decisions are working. A CVP analysis can help determine this. For example, if a company isn’t selling the required number of units to hit their break-even point, then the product or service needs to be reevaluated in terms of pricing or marketing efforts. 

It also helps with long-term considerations such as budgeting and creating a business plan or financial forecast.

Risk management

A business can use CVP analysis to explore how certain factors might have an impact on overall profits and plan accordingly. For example, businesses will be able to manipulate the variable cost amount in their formulas to see how much they need to go up by before the break-even point is impacted. 

By carrying out these forecasts, they’ll be able to create mitigation plans in the event of market fluctuations or unexpected cost rises.

Common mistakes to avoid in CVP analysis

While CVP analysis is an excellent revenue projection tool, there are a couple of notable limitations that need to be taken into account:.

Ignoring market dynamics

Certain costs, mostly variable, are often influenced by external factors that have an impact on price, like the availability of raw materials. If a business ignores the fact that many parts of the supply chain might be affected by this, there might be a nasty shock in store when it comes to factoring these new costs into the analysis.

Overlooking cost variability

The cost per unit is not constant. While some businesses take into account their different fixed and variable costs, they sometimes don’t appreciate that variable costs fluctuate considerably. If sales volume doubles from one month to the next, it doesn’t automatically mean that the total variable cost will double as well. Sadly, it’s not a linear relationship.

Conclusion: Leveraging CVP analysis for business success

No business wants to rely on guesswork to help plan its pricing strategies or forecast its financial future. 

With CVP analysis, businesses are able to take advantage of their existing business metrics to try and gauge where they’re at and where they’re heading. It allows them to understand how much of a product needs to be sold in order to break even, thereby avoiding a loss for the business. A strong contribution margin ratio is often a great way of seeing that a business is doing well, and the plans that have been put in place are working.

An accurate CVP starts with accurate business bookkeeping. QuickBooks financial reporting, income and expense tracking can help you organize your finances and gather all of the information you need to make valuable predictions. Try it for free today to see what’s possible.