Break Even and Cost Volume Profit Analysis
When can you say a business is either good or bad? Quite simply, it's good if the money earned is more than the money spent. It's bad when what you spent is more than the revenue you received.
Key Takeaways
Your break even point is when you have no profit, but also no loss.
A cost volume profit analysis or CVP is used to find out how much sales we need to reach a certain target profit.
The break even analysis is used to find out how much sales is needed for the business to break even.
The amount of money you spend to run the business and how much money comes back in will help you decide whether business is good or bad.
However, before looking at how much revenue comes into the business, one must first determine how much the business spends. A business has to types of spending: long-term and short-term.
For example:
The spend of a new lemonade shop, is long-term.
The spend of lemons, supplies, rent, salary, etc., is short-term.
When the lemonade shop breaks even, we are generally only comparing money earned against the short term stuff, like:
the ingredients which go into your lemonade,
the salary, you might pay to your lemonade maker and shop manager,
the insurance and rent for your shop,
advertising of your lemonade,
taxes for your business, and other similar things.
When can you say a business is good or not?
It’s neither good nor bad when: You earn enough from selling lemonades to pay for these short term things, we may say that a company has reached its break even point.
It’s bad when: You're not selling enough lemonade and not earning enough to pay for these short term things, your business is said to be losing money.
It’s good when: You're selling more than enough lemonade to earn more than enough money to pay for these short term things, this extra earnings is called profit.
Break Even Analysis
If your lemonade shop is is at its break even point, you're not in a good situation (but you're also not in a bad situation). You have no profit, but also no loss.
With every business, you want to target and hit the break even point so that you don't lose money. The Break Even Analysis is when you try to find out how much sales you need so that your business can break even.
Cost Volume Profit Analysis or CVP
After a while, you will want to do better than just break even. You'll want your business to have some profit eventually. To find out how much sales you need to be profitable, you will run a cost volume profit analysis, or CVP.
With cost volume profit analysis, you will try to find out how much sales is needed to reach a certain target profit.