The Cost Volume Profit (CVP) relationship is a correlation brought about by the costs and sales volumes. It has a greater impact on an organization’s potential regarding profit-earning in the long run. Although profit is defined as the difference between generated revenue and total costs met to generate the revenue, there are various steps put in place in companies’ financial statements for its measurement. Hence, it is pivotal to understand the role of both sales and costs in the profitability of any organization.
In the determination of profits, the factor of costs is bound to arise. Primary factors in profit calculations include revenues and costs. The relationship between costs and profits is inversely proportional in that an increase in costs translates to lowered profits. Consider a moving company choosing between a small track that makes several trips to move goods at $50 per trip, and a bigger truck is making a single trip at $80. If the company chooses to keep down its costs by taking the larger vehicle, then it is bound to impact positively on its profits. However, if they go with the former choice, profits are bound to be on the lower margin since the costs will be much higher in the end.
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Sales volumes relate to total amounts of products or services sold out expressed in terms of unit quantity or dollar aggregate. Consider an organization that can sell out 600 units of a given commodity making a $10,000 sales volume in that month. Making an assumption that the sales surpass the variable costs, any additional sale on top of the usual 600 units increases the total profit of the organization.
Lowering costs, increasing sales volumes, or a combination of the two has positive impacts on the profitability of any organization. It is safe to conclude that the two factors are interrelated in the determination of profits in firms. It is, therefore, important to put them into consideration to maximize on profit generation.
