Need for CVP Analysis

Cost-Volume-Profit analysis, or CVP analysis, studies how changes in sales volume influence revenue, costs, and profit.
This analysis is important because managers often face decisions about pricing, cost control, and sales growth.
Consider Prim Pharma, a pharmaceutical company that sells only medical care kits for fifty dollars per unit.
The variable cost is thirty dollars per unit, and the fixed costs are one hundred thousand dollars.
Prim Pharma is considering reducing the selling price to forty-five dollars to boost sales.
If sales rise from six thousand to seven thousand units, total revenue increases from three hundred thousand dollars to three hundred fifteen thousand dollars.
However, due to an increase in total variable costs from one hundred and eighty thousand dollars to two hundred and ten thousand dollars, the total costs also increase, and net operating income drops from twenty thousand dollars to only five thousand dollars.
Even though sales go up, net operating income falls because the lower selling price reduces the contribution margin on each unit.
CVP analysis helps managers see this trade-off clearly and avoid decisions that may reduce profitability.