3 accounting questions
Your friend remarked, “A company will never drop a product from its product line that has a positive contribution margin. It will want to garner every bit of profit that it can.” Is this true in all cases? What are the risks and benefits of evaluating product continuation or implementation using the contribution margin?
1)
In this case it is important to evaluate what the friend means by positive contribution as it can be lower and higher. It is important for the firm to have an overall high product contribution in order to maintain a high profit level. The contribution levels for all products must be analysed in order to calculate the contribution of each of the products to the overall profit level (Contribution Margin, (n.d)). Hence in these examples given above we see that if any product has a positive but low contribution, then that specific product must be dropped from production the respective year due to the lack of resources so that it does not dilute the high contribution level of other products and ultimately the overall contribution level. Hence the resources for each product is very important when it comes to the decision of dropping a product based on its contribution level as a product will have low contribution if the resources for the same are low. The risk of using such an analysis is that we lose out on unanticipated increase in demand of the product that is dropped. The benefit of this analysis is that we know which products to drop in order to maintain a high profit level for all the products that are produced by the company.