Contribution Margins

Cost-volume-profit Analysis: Calculating Contribution Margin Financial statements are used by managers to help make good business decisions Income statement shows managers the relationship between sales, costs, expenses. Allows managers to: Determine the level of sales required to achieve target net income Evaluate the impact of changes in sales volume, unit sales price, and unit costs on net income Identify the strengths and weaknesses of a company

Total costs – all costs for a specific time period Unit costs – amount spent for one unit of a product or service Units should be expressed in terms that are meaningful; helps managers in setting unit selling prices and planning cost control Variable costs – costs that change in direct proportion to a change in the number of units. (the unit variable cost remains the same regardless of number of units) Fixed costs – costs that remain constant Gross profit is calculated by subtracting cost of merchandise sold from net sales

Contribution Margin Income calculated by subtracting variable costs from net sales Helps managers determine income available to cover fixed costs and show profit Contribution margin = net sales – total variable costs Contribution margin income statement groups all costs into variable or fixed categories CM helps determine the income available to cover fixed costs and provide a profit

Contribution Margin per Unit Contribution margin per unit ÷ ⁼ Total Contribution Margin Units Sold

Calculating Breakeven Point Amount of sales in which net sales is equal to total costs is called the breakeven point. Neither net income or net loss at breakeven point Net income occurs when sales levels are above breakeven point Net loss occurs when sales levels are below breakeven point

Calculating Breakeven Point The breakeven point: Allows managers to determine the amount of sales needed to begin earning a profit Stated in sales dollars or unit sales The amounts required to calculate a breakeven point are obtained from an income statement prepared to report contribution margin. Management uses an alternative method to determine breakeven with new products to determine how many units must be sold to break even.

Breakeven Breakeven income statement - projection of sales and costs under specific assumptions. If the breakeven point is accurate, net income is zero. Breakeven analysis – used to calculate the dollar and unit sales needed to earn a specified amount of planned net income Businesses that sell two or more products can also use breakeven point calculations to assist managers in planning Relative distribution of sales among various products is called sales mix. The sales mix must be calculated to determine the breakeven point for a company that sells more than one product.

Calculating Breakeven Point Step 1: Cont. Margin ÷ Net Sales = Cont. Margin Rate Step 2: Total Fixed Costs ÷ Cont. Margin Rate = Sales Dollar Breakeven Point Step 3: Sales Dollar Breakeven Point ÷ Unit Sales Price = Unit Sales Breakeven Point

Calculating Breakeven Point for New Products Step 1: Unit Sales Price – Variable Cost Per Unit = Cont. Margin Per Unit Step 2: Total Fixed Costs ÷ Cont. Margin Per Unit = Unit Sales Breakeven Point Step 3: Unit Sales Breakeven Point x Unit Sales Price = Sales Dollar Breakeven Point

Calculating Sales to Earn Planned Net Income (Target Net Income) Determining the breakeven point helps management understand the relationship of sales, variable costs, and fixed costs Managers need information that will help them in achieving planned net income (target net income). The breakeven analysis can be used to calculate the dollar and unit sales needed to earn a specified amount of planned net income (target net income).

Calculating Sales to Earn Planned Net Income (Target Net Income) Step 1: Total Fixed Costs + Planned Net Income = Required Contribution Margin Step 2: Required Cont. Margin ÷ Cont. Margin Rate = Sales Dollars Businesses must determine the change in net income that results from changes in the relationship of sales, variable costs, and fixed costs.