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What Is Profit Analysis?

Charles K. Furr
Charles K. Furr

At heart, profit is the monetary gain a business produces after paying for inventory, equipment, payroll, and any other items required to operate the business. A dictionary definition of analysis might read as a breakdown of the whole into parts so as to identify what each aspect of the whole is. Putting the two words together, it can be determined that a profit analysis is a breakdown of the elements of a business, applying monetary amounts to each element, and performing calculations to determine what the profit is.

In the business world, a profit analysis, most often referred to as Cost/Volume/Profit (CVP) analysis, is normally used to determine "what if" scenarios. For example, the business Mary's Dolls wants to sell more Baby Jane dolls by decreasing their price. Mary's Dolls would perform a CVP analysis to determine potential profit. Mary's Dolls might choose to look at both the break even point, the point at which zero profit is produced, and the projected profit desired as their goal. Depending upon the results, Mary's Dolls could choose to lower the price of the Baby Jane dolls, or the company could realize lowering the price would be catastrophic—that the company would never be able to sell enough Baby Jane dolls at the lowered price to make a profit.

Profit analysis compares cost and volume to determine profit.
Profit analysis compares cost and volume to determine profit.

This example demonstrates that profit analysis is basically comparing cost and volume to determine profit. In order to use the analysis effectively, it is essential a business have a thorough knowledge of both its variable and fixed costs. If the figures are incorrect for any costs, the profit analysis would result in misleading figures and might cause a company to make a bad business decision.

Even when all figures are correct, a CVP analysis is limited in its usefulness and should be used in conjunction with other factors and calculations before making a final business decision. A CVP analysis is limited in scope because, in order for the calculations to work, the analysis has to make certain assumptions that are straightforward and inflexible. Such assumptions include things like the cost of parts remaining the same, the cost of electricity not increasing, sales remaining at a fixed point, employee's wages remaining the same, etc. Such items fluctuate in the real world and impact a business.

The example above deals with the CVP of one product for Mary's Dolls. In order to look at how the company as a whole is doing, the business would run a gross profit analysis, incorporating all products and costs. This type of analysis is very helpful for a company wanting to identify weak areas or products. It can pinpoint potential problems so they can be addressed in a timely manner.

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    • Profit analysis compares cost and volume to determine profit.
      By: Dmitry
      Profit analysis compares cost and volume to determine profit.