In this lesson we'll expand our knowledge even further about cost-volume-profit analysis. We'll talk about how to interpret cost-volume-profit analysis, but then also identify its limitations and assumptions that are inherent to cost-volume-profit analysis. Let's turn back to our GnG Landscape setting where our managers were evaluating the sod business. Again, managers consider revenues and costs on a per roll basis. And our normal information is that the average revenue for each roll is $5. The average variable cost per roll is $3. And we're thinking about our business on a month to month basis where the total fixed costs for any given month average out to be $20,000. Let's turn to some further calculations. So recall that our main equation is the break even quantity is equal to total fixed costs divided by the selling price per unit minus the variable cost per unit. And that will tell us the number of units that it takes to break even. And in our original example that was $20,000 of fixed costs per month divided by $5- $3, or $2 on a contribution margin per unit basis. And that meant that if we were to produce and sell 10,000 rolls of sod, we would earn zero profits. We would break even. Now, this tool is much more powerful than just calculating a single number. Going back to what we mentioned before, we can ask a series of what if questions and use this analysis to address those. So what if, instead of spending $20,000 per month in fixed costs, what if we had to spend $24,000? Perhaps the firm decided to make an investment in its sod business, and that increased our fixed costs on a month to month basis. Well, we could use the same exact equation to calculate what the impact on the break even point would be if our fixed costs were to change. We would use the same equation. Our break even quantity is our fixed costs which now amount to $24,000 per month, and everything else is exactly the same. The average selling price is 5, and the average variable cost is 3. So in this case we would have $24,000 divided by $2 of contribution margin per unit, or 12,000 units or rolls of sod to break even. And you can see the impact on the break even point of what this change in the fixed costs would be. Suppose instead of fixed cost changing, we would see variable costs changing. Perhaps the cost of seed and sod, or the labor wages that we have to pay for people to cut it and roll it and deliver it, have increased from $3 per unit to $4 per unit. Well again, we can calculate what the impact is of that change on the break even quantity. Let's assume that fixed costs did not change in this month but variable costs did. And that is that we have $5 in selling price minus the revised variable cost per unit of $4. Well now, instead of breaking even with 10,000 units of sod, we now would break even with 20,000 units of sod. So, you can see that the change in the variable costs on a per unit basis increased our break even point in this scenario substantially. Of course, we can ask, what if we change the selling price then per unit? What if some competitors introduced into the market a more expensive sod? And we could find we have an opportunity to increase our contribution margin. So let's say that the selling price on a per unit basis moves from $5 per roll to $7. Variable cost is the original 3, and our fixed costs remain the same again at $20,000 dollars per month. Well again we can calculate what the quantity is that it takes to break even, given the change in the selling price. Our numerator stays the same at 20,000. Our denominator evolves from 5- 3 to 7- 3. And now we've calculated the revised break even point at 5,000 rolls of sod. $20,000 divided by the revised contribution margin, which went from 2 to now 4. So you can see a change in the selling price, in particular an increase, decreases the number of units it takes to break even. Now what happened if everything changes all at once? What if we decide to change our selling price from 5 to 7? Our variable costs change from 3 to 4, and our fixed costs change from the original $20,000 per month to $24,000 per month. What would you predict what would have happen here? Well it's very difficult to make this prediction because all of the different parameters are changing at different rates. So to find out what the impact on the break even point would be, we just have to run our equation once again. Our break even quantity in this case would be the revised fixed costs on a month to month basis of $24,000 divided by the contribution margin per unit. Or a function of the selling price of $7 per roll minus the revised variable cost per roll of $4. The denominator evolves to a contribution margin unit of $3 per unit. Dividing that into our total fixed costs yields $8,000, excuse me, 8,000 rolls of sod to break even under this new environment. Now, as you can see, cost volume profit analysis is incredibly powerful. You can ask all sorts of what if questions, and even combine different changes to parameters to see what the effect on your break even point would be. Let's have a checkpoint to make sure that we're all on the same page.