What it means
The chart has sales volume along the bottom axis and profit or loss up the side. At zero sales, the business still pays its fixed costs, such as rent and salaries, so the line starts below zero at minus the amount of those costs.
Each unit sold then adds its contribution, which is the selling price minus the variable cost, and the line rises in a straight path. The slope of the line equals the contribution per unit.
A steeper line means each extra unit adds more profit. The point where the line crosses the horizontal axis is the break-even volume, below which the business makes a loss and above which it makes a profit.
Managers use the chart to see at a glance how sensitive profit is to sales. It makes questions easy to answer, such as how many more units are needed to reach a target profit, or how far sales can fall before a loss.
It is simpler to read than a table of numbers, which is why it is often used in management meetings. The chart can be redrawn to test decisions.
A price rise steepens the line, a fall in variable cost does the same, and a rise in fixed costs lowers the starting point. Drawing the old and new lines together shows exactly how a proposal changes the break-even point.
The method has limits. It assumes price and variable cost per unit stay constant and that fixed costs do not change within the range shown, which may not hold for large changes in volume.
For a business selling several products, the chart works with an average mix. Related is the profit-volume ratio, the contribution divided by the selling price.
It tells you how much of each extra dollar of sales turns into profit once fixed costs have been covered.
In practice
Real-world examples.
Example
A cafe owner plots her daily profit against coffees sold. She sees that 220 cups are needed to cover rent and wages, and that every extra cup after that adds $2.50 of profit. On a quiet day she knows to cut hours rather than cut prices.
Example
A manufacturer considers a machine that lowers variable cost per unit from $12 to $10 but adds $60,000 of fixed costs a year. The new line is steeper but starts lower, and the chart shows the machine only pays off above a certain volume. The lines cross at 30,000 units a year, so the manager buys it only if she is confident of selling more than that.
Example
A training company compares two course formats on one chart. The online format has low fixed costs and a shallow line, while the classroom format has higher fixed costs and a steeper line. The lines cross at a volume that helps the manager decide which to run.
Formula
Calculation
Profit = (price - variable cost per unit) x units - fixed costs; break-even units = fixed costs / contribution per unit
Suppose a product sells for $50 with a variable cost of $30, so the contribution is $20 per unit, and fixed costs are $100,000. At zero units the loss is $100,000. Break-even is 100,000 / 20 = 5,000 units. At 8,000 units, profit is 20 x 8,000 - 100,000 = 160,000 - 100,000 = $60,000, and the profit-volume ratio is 20 / 50 = 40%.Case study
Seen in the real world.
Calderbank Cycles is an illustrative, fictional bicycle maker considering a new electric model. Each bike would sell for $1,800 with variable cost of $1,200, and the project would add $720,000 a year in fixed costs for staff and tooling.
The finance manager drew a profit-volume chart for the board. It showed a contribution of $600 per bike and a break-even of 720,000 / 600 = 1,200 bikes a year, while the sales team's cautious forecast was 1,500. The board approved the launch, with the illustrative note that a drop in demand of more than 20% would produce a loss.
Six months after launch, sales ran at 1,350 bikes a year, giving a profit of 1,350 x 600 - 720,000 = $90,000. The illustrative finance manager kept the chart on the wall of the meeting room and updated it each quarter with actual volumes.
Watch out
Common mistakes.
- Assuming the line stays straight at all volumes, when step costs and discounts can change the slope.
- Forgetting that fixed costs set the starting point of the line below zero.
- Using the chart for a multi-product business without a realistic sales mix.
Questions
People also ask.
How is a profit-volume chart different from a break-even chart?
A break-even chart shows revenue and cost lines crossing, while a profit-volume chart shows profit directly as a single line.
What does the slope of the line show?
It shows the contribution per unit, or the profit added by each extra unit sold.
What does the area below the axis represent?
It shows the volumes at which the business makes a loss.
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