What are the assumptions of CVP analyses?

Cost-Volume-Profit analyses make several simplifying assumptions:

  • the price per unit is constant;
  • costs can be separated into a variable and fixed component;
  • the unit viable cost is constant;
  • fixed costs are constant;
  • there is a single cost driver or the product mix is constant;
  • sales equal production (inventory level does not change).

While these assumptions are not realistic, they help understand the mechanisms underlying profit generation. Moreover, the results of CVP analyses are often quite robust, at least within a relevant range. More importantly, it is the basis on which managers can think and communicate about the consequences of their decisions. We will now see how by looking at how decisions affect the CVP graph and the major aggregates we have computed so far.