He contribution margin Is the value that should result from the difference between the selling price minus the variable costs.
In other words, it is the surplus of disposable income for the investor once the variable costs are excluded. Thus, the contribution margin must cover both the fixed costs and the expected profit (profit) (Investopedia, 2017).
Fixed costs are the expected and predictable expenses that take place within a productive process. The profit, on the other hand, is the gain that is obtained derived from this productive process, once the produced one is sold.
On the other hand, variable costs are those that can change according to the activity of a company and the number of units of product manufactured.
The total cost of a product is determined by the sum of fixed costs and variable costs. In this way, the contribution margin is determined by excluding the variable costs of the sale, resulting in only one item covering both fixed and utility costs (Peavler, 2016).
Contribution Margin Variables
Commercially, all products are assigned a sale price. This sale price is composed of three concepts: fixed costs, variable costs and utility (AccountingCoach, 2017). These terms are defined as follows:
Fixed costs
Fixed costs, as the name implies, are those that remain unchanged for a certain period of time, regardless of the volume of production that a company has.
That is, if the company is going to carry out a mass production or a small sample, the fixed costs are always the same.
A clear example of fixed costs can be the rent value of a commercial premises, or the lease of land needed to carry out the productive processes of a company.
The monthly payment for said property will always be the same, regardless of the amount of elements that the company produces.
However, a fixed cost such as leasing a commercial premises can become variable if it is measured by production units issued by a company for a month.
That is, if the production and sales volume of a company increases over a certain period of time, the fixed cost of leasing that is charged to each product decreases.
For example, if the monthly lease cost of a commercial premises is USD 1,000, and the company in a given month produces 1,000 products, the fixed cost charged to each product will be USD 1.
On the other hand, if you only produce 500 products, the fixed cost will be USD 2. Therefore, it would seem that the value assigned as a fixed cost to each product has varied, and for this reason must be taken into account as a variable cost.
Variable costs
They are those that can be modified depending on the volume of production given. In this sense, if a company does not produce anything, there are no variable costs, but if the company increases its production volume, it will also increase the value of its variable costs.
In this sense, it can be said that variable costs are contingent on the number of units produced. A good example of this can be the raw material, which is consumed exclusively according to the quantity of units produced.
For example, in the case of the purchase of the raw material, a variable cost may become fixed. Let's say a company needs to invest USD 200 in materials to produce a particular article. If you wanted to produce 5 items, this means you would need to invest USD 1,000 in raw material.
In this way, the cost of raw material is variable in that it can change as the number of items to be produced increases or decreases.
On the other hand, it is fixed in that it will always be necessary to invest the pampering USD 200 to produce a single article.
Utility
The utility is defined as the total value or percentage that the investor or producer wants to obtain as a gain on the invested value (variable cost + fixed cost).
In this sense, if a producer wants to earn a profit margin of 20% on the sale of a product whose cost is USD 5,000, he must sell said product for USD 6,000, obtaining a profit of USD 1,000 corresponding to said 20%.
How to calculate the margin of contribution?
To calculate the contribution margin derived from the production of an element it is necessary to apply the following formula: MC = PVU - CVU.
Where MC is Contribution Margin, PVU corresponds to the Unit Sales Price and CVU refers to Unit Variable Cost (Debitoor, 2017).
In this sense, if the sale price of a product is USD 6,000 and its variable costs are USD 3,000, this means that:
MC = 6,000 - 3,000
MC = 3,000
Why is the Contribution Margin important?
As its name indicates, the contribution margin aims to indicate how much the production of a particular article is contributing to the economic stability of a company.
In this way, it allows to determine how profitable it is to continue with the production of said article.
Some events that can be analyzed thanks to the contribution margin are the following:
Negative contribution margin
When variable costs are higher than the sales price, the contribution margin is said to be negative.
In this scenario, the production of this article would be facing a critical moment and should be suspended.
Positive contribution margin
When variable costs are lower than fixed costs, the contribution margin is said to be positive. In this case, this margin must absorb the heading assigned to the fixed costs and contribute with the generation of the expected gain.
The higher the contribution margin, the greater the gain. This is because the fixed cost always remains unchanged, so what increases within the value of the contribution margin is the utility.
When the contribution margin does not reach
When the contribution margin does not cover fixed costs, the company runs the risk of running out of capital.
In this case it is essential to take measures to ensure that the margin covers fixed costs in their entirety and not in a partial way. On the other hand, attention should be focused on producing a profit margin too.
When the contribution margin is equal to the fixed cost
In this case, the production of an article would not be leaving profits or profits, so production is considered to be in equilibrium (not losing or making money) (Gerencie.com, 2012).
References
- (2017). AccountingCoach . Retrieved from"What is contribution margin?: accountingcoach.com"
- (2017). Debitoor . Retrieved from"What is the contribution margin?: debitoor.es
- com. (June 12, 2012). Manage . Retrieved from Contribution Margin: gerencie.com
- (2017). Investopedia . From Contribution Margin: investopedia.com
- Peavler, R. (May 10, 2016). The Balance . Retrieved from"What is the Contribution Margin?: thebalance.com.