Running a successful small business requires adept navigation of the many choices created by an ever changing market place. Cost Volume Profit Analysis (CVPA) is an effective tool that can help its user answer important questions such as "what price should I charge for this product or that service?", "which of my products or services is most profitable?", and "what is the best operating leverage level for my business given current market conditions?" Understanding Fixed, Semi-Variable, and Variable Costs

Before the CVPA can be used, fixed, semi-variable and variable costs must be determined. Determining these costs is a very useful tool in itself, but that’s another white paper.

Fixed costs are those costs that your business incurs regardless of sales volume. These are costs such as rent, insurance, and annual business licensing fees. Sales volume, not exceeding your current capacity, has no effect.

Variable costs are those costs that are directly affected by sales volume. These include items such as cost-of-goods sold, sales commissions, and travel expenses, if you are a service provider that travels as a result of service provision.

Semi-variable costs, as you have determined by now, are those costs that increase with sales volume but not directly as with variable costs. An example of a semi-variable cost for an auto body shop might be equipment maintenance expense. At some point, equipment begins to break down if not maintained at a level consistent with increased use. Therefore, in order to avoid equipment breakdown due to hyper-use, the business owner must spend additional funds on maintaining equipment.

Break-Even

There are several benefits to using CVPA. First, it shows what the break-even point, in units or dollars, for a given product or service is, given a specified sales price. Break-even is the point at which sales revenue covers all fixed costs for the year plus all variable costs up to that sales point. For example, if fixed costs for the year are $1,000, variable costs per unit total $1.00, and the product is priced at $5.00, then 250 units must be sold to cover fixed and variable costs totaling $1,250.

As you may have noticed, not only does CVPA show break-even, but it can be used for analyzing price sensitivity. For instance, if your competitor is able to price the same product at $2.50, but you are not able to go below $3.00, then it may be time to consider several options: discontinue the product, find a way to reduce fixed and variable costs so you can price it at $2.50, tweak the product in some way that distinguishes it in a positive way from your competitor’s—a square hamburger vs. a round hamburger—or use the product as a "loss leader" to get customers in the door.

Contribution Margin

Determining the contribution margin for your business is an additional benefit of CVPA. Contribution margin is simply the amount of each sales dollar left after all variable costs have been covered. It is that portion of the sales dollar that can be devoted to covering fixed costs.

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