Assumptions of Cost-Volume-Profit (CVP) Analysis:

Learning Objectives:

1. What are underlying assumptions of cost volume profit (CVP) analysis?

A number of assumptions underlie cost-volume-profit (CVP) analysis: These cost volume profit analysis assumptions are as follows:

1. Selling price is constant. The price of a product or service will not change as volume changes.
2. Costs are linear and can be accurately divided into variable and fixed elements. The variable element is constant per unit, and the fixed element is constant in total over the relevant range.
3. In multi-product companies, the sales mix is constant.
4. In manufacturing companies, inventories do not change. The number of units produced equals the number of units sold.

While some of these assumptions may be violated in practice, the violations are usually not serious enough to call into question the basic validity of CVP analysis. For example,  in most multi-product companies, the sales mix is constant enough so that the result of CVP analysis are reasonably valid.

Perhaps the greatest danger lies in relying on simple CVP analysis when a manager is contemplating a large change in volume that lies outside of the relevant range. For example, a manager might contemplate increasing the level of sales far beyond what the company has ever experienced before. However, even in these situations a manager can adjust the model as we have done in this chapter to take into account anticipated changes in selling price, fixed costs, and the sales mix that would otherwise violate the cost volume profit assumptions.

You may also be interested in other relevant articles:

• Contribution Margin and Basics of CVP Analysis
• Difference Between Gross Margin and Contribution Margin
• Cost volume profit (CVP) relationship in graphic form
• Contribution margin ratio (CM ratio)
• Importance of the contribution margin
• CVP consideration in choosing a cost structure
• Operating leverage--degree of operating leverage
• Assumptions of CVP analysis
• Break even point analysis
• Target profit analysis
• Margin of safety
• Sales mix and break even with multiple products
• Limitations of Cost Volume Profit Analysis

 

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