Profit-volume chart definition
/What is a Profit-Volume Chart?
A profit-volume chart is a graphical representation of the relationship between the sales and profits of a business. The concept is especially useful for determining an organization’s breakeven point, where the sales level generates a profit of exactly zero. For example, a firm has $5,000 in fixed costs and earns $20 per unit in profit; it would need to sell 250 units to reach breakeven (calculated as $5,000 fixed costs divided by $20 profit per unit). A sample profit-volume chart appears in the following exhibit.
Advantages of a Profit-Volume Chart
Breakeven information is critical for adjusting the expenditure and margin levels of a business to improve the probability that it will earn a profit. A profit-volume chart can also be used to estimate the profit that will likely be earned based on a certain sales level.
The managers of a business should have an especially high familiarity with the entity's profit-volume chart when the firm has a high fixed cost level. The reason is that the company must attain a high sales volume just to earn enough money to cover fixed costs. If sales drop below this breakeven level, a high fixed-cost business could lose a substantial amount of money.
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Example of a Profit-Volume Chart
As an example of a profit-volume chart, a company manufactures and sells a single product with the following financial information:
Selling price per unit: $50
Variable cost per unit: $30
Fixed costs: $20,000
The steps required to create a profit-volume chart from this information are as follows:
Calculate the contribution margin per unit:
Contribution margin = Selling price - Variable cost = $50 - $30 = $20 per unitDetermine the break-even point (in units):
Break-even point = Fixed costs / Contribution margin per unit = $20,000 ÷ $20 = 1,000 unitsPrepare data for the chart:
Sales below 1,000 units: The company incurs a loss.
Sales at 1,000 units: The company breaks even (no profit, no loss).
Sales above 1,000 units: The company generates a profit.
Example data for the chart:
500 units: Profit = (500 × $20) - $20,000 = - $10,000 (Loss)
1,000 units: Profit = (1,000 × $20) - $20,000 = $0 (Break-even)
1,500 units: Profit = (1,500 × $20) - $20,000 = $10,000 (Profit)
Disadvantages of a Profit-Volume Chart
The profit-volume chart can be excessively simplistic for a business that offers a broad range of products, each one with a different margin. In this situation, it may make more sense to develop a separate profit-volume chart for each product line, on the assumption that margins are roughly the same within each product line.
FAQs
How is a profit–volume chart used in strategic decision-making?
A profit–volume chart is used in strategic decision-making to assess how changes in sales volume, pricing, or cost structure affect profitability. It helps management evaluate the profit impact of strategic options such as price reductions, automation, outsourcing, or market expansion. By visualizing profit sensitivity and operating leverage, it supports informed trade-offs between risk and expected return.
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