Profit-volume chart definition

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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:

  1. Calculate the contribution margin per unit:
    Contribution margin = Selling price - Variable cost = $50 - $30 = $20 per unit

  2. Determine the break-even point (in units):
    Break-even point = Fixed costs / Contribution margin per unit = $20,000 ÷ $20 = 1,000 units

  3. Prepare 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.