Cost-volume-profit (CVP) analysis is useful tool used to determine how changes in costs and volume affect a company’s operating income and net income. In performing this analysis, there are several assumptions made, including: Sales price per unit is constant. Variable costs per unit are constant. Total fixed costs are constant.
It’s not suitable for every business, but I’ve personally found it very useful when thinking about new ventures, as a useful way of deciding on a projects viability.
It’s difficult to think about what volume of business you’d need to hit to make a suitable income, but using CVP analysis, allows you to work backwards, starting with what you’d need to take out of it, to make it worthwhile, and getting to a turnover figure you’d need to hit to make that happen. With that in hand you can easily work out how many customers you’d need to attract each day, week, or month to make it a success.
Let’s say you want to make £100 per day driving a taxi, you estimate you’ll need to pay £25 per day for the rent of the taxi which are your only fixed costs (FC).
The only other costs you will have is the fuel you use throughout the day. You’re advised by other drivers that you’ll need approx £30 of fuel. Once you’ve actually done a few shifts you can work out if you’ve been accurate in estimating this figure. The fuel comes under Cost of goods sold, which increase the more work you do, or decreases the less work you do (more mileage done, more fuel used).
So your costs are as follows;
- FC = £25
- COGS = £30
- NP = £100 Nett profit is the amount you’re going to make after all costs are taken care of
- Turnover = £155 (this is NP+COGS and FC all added together)
- GP = £125 Gross profit is TO-COGS
With this information we can work out what percentage your gross profit is likely to be; using the following calculation – GP divided by TO multiplied by 100 (125/155*100 = 80% approx.).
So your GP is 80%.
If you wanted to increase your income (NP) to £150 per night, your FC would be still £25 per night (for the rent). So your gross profit would now need to be £175 (£150 plus £25), if you now divide £175 by .80 (80% GP) on your calculator, you’ll get the TO figure of £218.75. The difference of £218.75 and £175 is £43.75, which is your COGS, in this case your fuel usage.
If you had a bad night and only made £50, it would look like this…
NP + FC = GP
£50 + £25 = £75
£75 divided by .80 (80% GP) = £60 which would be your TO.
So you can see that working things out using CVP analysis allows you to build in different scenarios to see how TO is impacted by how much NP you are wanting to make.
You can then try to figure out if your more likely to be earning £50, £100 or £150 for a typical day of taxi driving, and what is the most likely figure. You can always use it to do further research like asking other drivers what you should expect to earn.
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