Contribution margin
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Contribution margin analysis is a relatively simple tool afforded by cost/volume/profit analysis. In simplest terms, the contribution margin is total revenue minus total variable cost. This difference can be expressed as a percentage of total revenue. A company's contribution margin can be expressed as the percentage of each sale that remains after the variable costs are subtracted. Given the contribution margin, a manager can make better decisions about whether to add or subtract a product line, about how to price a product or service, and about how to structure sales commissions or bonuses. The contribution margin is computed using a special type of income statement that has been reformatted to group together a business's fixed and variable costs.
Here's an example of a contribution format income statement:
| Sales | $ 462,452 |
| Less Variable Costs: | |
|
$ 230,934 $ 58,852 $ 13,984 |
| Total Variable Costs | $ 303,770 |
| Contribution Margin (34%) | $ 158,682 |
| Less: Fixed Costs: | |
|
$ 1,850 $ 13,250 $ 5,400 $ 8,200 $ 9,600 $ 17,801 $ 40,000 |
| Total Fixed Costs | $ 96,101 |
| Net Operating Income | $ 62,581 |
The Beta Company's contribution margin for the year was 34 percent. This means that, for every dollar of sales, after the costs that were directly related to the sales were subtracted, YO 34 cents remained to contribute toward paying for the indirect costs and for profit.
Contribution format income statements can be drawn up with data from more than one year's income statements, when a person is interested in tracking contribution margins over time. Perhaps even more usefully, they can be drawn up for each product line or service. Here's an example, showing a breakdown of Beta's three main product lines:
| Line A | Line B | Line C | |
|---|---|---|---|
| Sales | $120,400 | $202,050 | $140,002 |
| Less Variable Costs: | |||
| Cost of Goods Sold | $70,030 | $100,900 | $60,004 |
| Sales Commissions | $18,802 | $40,050 | $0 |
| Delivery Charges | $ 900 | $ 8,084 | $ 5,000 |
| Total Variable Costs | $ 89,732 | $ 149,034 | $ 65,004 |
| Contribution Margin | $ 30,668 | $ 53,016 | $ 74,998 |
| percentage | (25%) | (26%) | (54%) |
Although this shows only the top half of the contribution format income statement, it's immediately apparent that Product Line C is Beta's most profitable one, even though Beta gets more sales revenue from Line B. It appears that Beta would do well by emphasizing Line C in its product mix. Moreover, the statement indicates that perhaps prices for line A and line B products are too low. This is information that can't be gleaned from the regular income statements that an accountant routinely draws up each period.
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