What is Cost-Volume-Profit analysis?
Cost-volume-profit (CVP) analysis is a management accounting technique used to analyze how changes in sales volume, selling price, and variable costs impact a company’s profitability. CVP analysis is based on the relationship between sales revenue, total costs, and the level of activity or volume.
CVP analysis can help tech startups make informed decisions about pricing, product mix, and resource allocation.
By understanding the relationship between sales volume, selling price, and costs, startups can evaluate the impact of different options on profitability and make the best decision for their business.
Here’s an example of how CVP analysis can be used in a tech startup:
Imagine a startup that sells a software-as-a-service (SaaS) product for $20 per month per user.
The variable cost per user is $5 per month. (imagine creating customer centric databases, object storage etc.,)
The total fixed costs are $10,000 per month. ( imagine overall infrastructure costs)
The startup wants to know the level of sales needed to break even and the amount of profit it will earn at different levels of sales.
To calculate the break-even point, we can use the following formula:
Break-even point = Total fixed costs / Contribution margin per unit
Contribution margin per unit = Sales price per unit — Variable cost per unit
Contribution margin per unit = $20 — $5 = $15
Break-even point = $10,000 / $15 = 667 users
Therefore, the startup needs to sell 667 users to break even.
To calculate the level of sales needed to earn a target profit, we can use the following formula:
Target profit = (Sales volume x Contribution margin per unit) — Total fixed costs
Target profit = ($20Q — $5Q) — $10,000
Target profit = $15Q — $10,000
If the startup wants to earn a target profit of $5,000, we can solve for Q:
$15Q — $10,000 = $5,000
$15Q = $15,000
Q = 1,000 users
Therefore, the startup needs to sell 1,000 users to earn a profit of $5,000.
