Contribution margin may be looked at from a variety of perspectives that often involve comparisons within different segments of a company. Data may be isolated by product, geographic area, salesperson, customer, distribution method, etc., and analyzed in terms of how individuals or entities within a segment perform in terms of contribution margin percentage. Managers may use these targeted results to discover strengths that may be capitalized on and/or weaknesses that may need to be addressed.
Let’s go back to Classic Boats, Inc. Your new boss handed you the following information for the month of July, compiled by the financial accounting staff:
| Description | Total |
|---|---|
| Sales | $ 156,000.00 |
| Cost of Goods Sold | $ 122,000.00 |
| Gross Profit | Single Line$ 34,000.00 |
| Selling, general, and administrative costs | $ 34,680.00 |
| Operating income | Single Line$ (680.00) |
| Provision for income taxes | $ – |
| Single Line$ (680.00)Double line | |
Her question to you was simple: Why are we losing money, and what do we have to do to make money?
She also noted that the company sold 26 custom sailboats in July at a price of $6,000 each.
By “data mining” through the accounting records, you come up with the following:
| Hulls | $2,000.00 | each |
| Outfitting | $1,000.00 | each |
| Labor per assembled boat | $1,500.00 | each |
| Sales Salary | $10,000.00 | per month |
| Commission | 3.00% | each |
| Fixed costs | $20,000.00 | per month |
| Production facility rent | $5,000.00 | per month |
| Sales Price | $6,000.00 | each |
Which you then sort into fixed and variable costs:
| Subcategory, Variable Costs | ||
| Hulls | $2,000.00 | |
| Outfitting | $1,000.00 | |
| Labor per assembled boat | $1,500.00 | |
| Commission | $180.00 | |
| Single Line$4,680.00Double line | ||
| Subcategory, Fixed Costs | ||
| Sales Salary | $10,000.00 | |
| Other fixed costs | $20,000.00 | |
| Production facility rent | $5,000.00 | |
| Single Line$35,000.00Double line | ||
From that, you can recreate the financials using a variable costing model:
| Units | $/Unit | Total | |
|---|---|---|---|
| Sales | 26 | $ 6,000.00 | $ 156,000.00 |
| Variable costs | 26 | $ 4,680.00 | 121,680.00 |
| Contribution Margin | $ 1,320.00 | Single Line34,320.00 | |
| Fixed costs | 35,000.00 | ||
| Operating income | Single Line$ (680.00)Double line | ||
| CM ratio | 22.00% |
When you run your break-even analysis, you see that they are just below break-even, which is fairly obvious even without the CVP calculation:
| Units | $/Unit | Total | |
|---|---|---|---|
| Sales | 27 | $ 6,000.00 | $ 162,000.00 |
| Variable costs | 27 | $ 4,680.00 | 126,360.00 |
| Contribution Margin | $ 1,320.00 | Single Line35,640.00 | |
| Fixed costs | 35,000.00 | ||
| Operating income | Single Line$ (640.00)Double line | ||
| CM ratio | 22.00% |
From here, you could run a sensitivity analysis to determine the effect of different assumptions. For instance, decreasing variable costs by a mere 1% results in the following:
| Units | $/Unit | Total | |
|---|---|---|---|
| Sales | 26 | $ 6,000.00 | $ 156,000.00 |
| Variable costs | 26 | $ 4,633.20 | 120,463.20 |
| Contribution Margin | $ 1,366.80 | Single Line35,536.80 | |
| Fixed costs | 35,000.00 | ||
| Operating income | Single Line$ 536.80Double line | ||
| Increase (decrease) over base | $ 1,216.80 | ||
| % increase (decrease) over base | N/A because base was negative | ||
| CM ratio | 22.78% |
As you can see, a variable costing model is extremely useful for managerial accountants in diagnosing problems and solutions, but it is only just a start. In this course, you will learn to use concepts and techniques like static and flexible budgets, standard costing with variance analysis, and responsibility accounting to further refine your skills in directing and controlling operations.
Contribution margin analysis is also useful for planning purposes. For each product, sales volume, unit selling price, unit variable cost of production, and unit variable cost of selling can be forecasted to estimate contribution margin. Subsequently, one or more of these four variables can be changed to see the impact on the contribution margin.
One final note: Variable costing may also be applicable to a service business, even though manufacturing costs are not involved. A small hotel, for example, earns revenue from renting rooms. Variable costs may include food and beverage expense for breakfast, supplies expense, selling expense, and an incremental utilities expense amount for times when rooms are occupied. Fixed costs of rent expense for the property, salaries expense, depreciation expense, and insurance expense are typical.
