Contribution Margin

What is 'Contribution Margin'
Contribution margin is a cost accounting concept that allows a company to determine the profitability of individual products. The phrase "contribution margin" can also refer to a per unit measure of a product's gross operating margin calculated simply as the product's price minus its total variable costs. This metric allows an entity to evaluate different areas of business to determine which service or product line to emphasize based on the highest margin.
BREAKING DOWN 'Contribution Margin'
Contribution margin is calculated by reducing the sales price by the total variable costs – regardless if the cost is materials, labor or overhead. For example, Company XYZ sells an item for $100. The company incurs a unit variable direct material expense of $12, unit variable labor expense of $25, $10 of variable overhead per unit and $8 of fixed overhead per unit. The contribution margin of one unit is ($100 - $12 - $25 - $10) $53 because the fixed overhead per unit of $8 is not considered.
Usefulness of Contribution Margin
Contribution margin is used by management when making pricing decisions. This is especially true in special pricing or special order situations where fixed costs are sunk costs and should not be factored into the decision whether to accept or reject. Negative or low contribution margins indicate a product line or business segment may not be profitable. In addition, the contribution margin is helpful to analyze the impact of different levels of sales. Finally, a business can use contribution margin to resolve bottlenecks. If limited resources are available, a business wants to contribute that scarce resource towards the most profitable items. Therefore, constraints are eliminated by awarding the most profitable items the resources.

Break-even or Target Income Analysis
The contribution margin is an integral aspect when calculating the break-even point of sales or a target level of sales. The contribution margin determines the portion of each sale that is attributed to covering fixed costs. For this reason, fixed costs divided by the contributionmargin results in the number of units needed to be sold to break-even. To find a target net income, the target amount is added to total fixed costs.

Contribution Margin Ratio
Contribution margin is directly related to the contribution margin ratio. The contribution margin ratio can be calculated on a per-unit basis or an aggregate basis. The per-unit basis divides the contribution margin per unit by the unit sale price, while the total contribution margin ratio divides the total contribution margin by the total revenue. The figure will result in a percentage that indicates what percentage of each dollar of revenue is generated to cover fixed costs. This metric is calculated by dividing the contribution margin by revenue.


Comments

Post a Comment

Popular posts from this blog

How to Choose Furniture for Your Home

     Choosing furniture for your home can be a lot of fun and anightmare. It can be difficult to find quality, comfortable accessories thatreflect and blend your own style to create a harmonious interior. You don't want to throw everything away either. The question arises as to which elements should be stored, covered or modified to fit the image of the room. In short, when choosing furniture, you need to consider both practical and decorative.   The furniture and its functions The first thing in deciding whether or not to use furniture is your job. Ask yourself what kind of furniture you need. Different functions can be performed in a special room that requires special furniture (bedroom, sofa, etc.). Think of everyone in the house. Does anyone like comfy lounge chairs? Need more storage space for all your kids toys? After reviewing these important questions, pay particular attention to the following:   One. Simple furniture in any room Each room or space in your
Read more

Five Reasons Why Companies Outsource Their Payroll

Managing accounting , human resources, payroll, tax , and other financialresponsibilities at the same time is a complex & time consuming affair. Many businesses still do all of these activities in-house, not realizing that such routine administrative work is getting intricate by the day, and is a big drain on their time. Accounting , payroll & human resources are some of the most commonly outsourced company functions. Here are the top 5 reasons why you should outsource your payroll. Complex rules and calculations With so many rules, by-laws, provident fund percentages for different age groups, employee benefit programs, employees joining & leaving and taxes to consider, it is becoming extremely challenging to process the exact salary and reimbursements of each employee. You must also be able to answer your employee's queries about their payroll confidently and clearly. Even if you can do all this by yourself, how can you be sure that everything has bee
Read more