M5A1: Budgeting and Balanced Scorecard Discussion
gouchogurl2007
ImportanceofContributionMarginDiscussion.docxUses of Contribution Margin
Importance of Contribution Margin
Direct material and direct labor costs are the variable manufacturing cost and following are the fixed manufacturing costs: factory rent, insurance, electricity and water. Annual direct material cost is $4384.40 and annual direct labor cost is $14,400. Thus, total variable manufacturing costs is $18,784.40. Total fixed manufacturing cost is $18,000.
Contribution margin is the percentage of contribution (which is difference between sales and variable costs) to sales. To compute contribution margin, we use the following formula:
(Revenue – Variable Costs) x 100 / Revenue
($72,910 - $18784.40) x 100 / $72,910 = 74.24%
Contribution margin help us in deciding the selling price in order to earn a specific amount of profit. For example, In the given case, if we want to make profit of $60,000, then the required revenue should be $105,070.10 (see the calculation below).
(Fixed Cost + Desired Profit) / Contribution Margin
($18,000 + $60,000) / 74.24% = $105,070.10
In deciding whether to accept a special order, contribution margin had a great role. If we have a spare capacity to produce extra units and due to that there is an increase in contribution, then we should go ahead and work on the special order.
Sometimes we need analyze the effect of additional advertising expenses of the business profits. In this again contribution margin plays a significant role. If due to additional advertising there is increase in sales revenue and generate additional contribution to contribute in business profits after covering additional advertising expenses, in such case incurring additional advertising expenses is fruitful for the business.
Reference:
Ray H Garrison, Eric Noreen and Peter C. Brewer Professor. Loose-leaf for Managerial Accounting. McGraw-Hill Education; 15th edition (January 3, 2014)
Page 1 of 1
