It's always important to know how much profit a company is making. Many business owners look at the profit margin. This is the amount of money made after-sales. However, if you want to know how much a certain product adds to a company's profit, you need to know the contribution margin. The contribution margin is a financial analysis tool that is often misunderstood by business managers. A contribution margin analysis Is a great tool for business managers to implement. As a matter of fact, it is one of the best tools for determining what is making your company money.
The Contribution Margin Formula
When a product is made and delivered, you add the variable costs. This leaves you with the contribution margin. It's a different method of looking at actual profit. You gain new information from a different perspective. You subtract the actual cost of goods to get a gross profit. Then you subtract operating expenses and then subtract taxes. But, when you also subtract the variable costs, that's when you're left with your contribution margin. The contribution margin reveals the amount of revenue available. This way, you know if you have enough money to cover fixed expenses and whether or not your making a profit. It is this sales portion that helps offset fixed expenses. The contribution margin formula is a simple one. You simply subtract the variable cost from the revenue to get your contribution margin. For example, if the cost of your product is $40 and the unit variable cost is $8, then the unit contribution margin is $32.
The first step in doing a calculation for contribution margin is to take the income statement and re-itemize all costs as either variable or fixed. Fixed costs are those that remain the same. For example, rent costs and administration costs remain the same. Variable costs differ. An example of a variable cost would be paid commissions. You must break down the fixed and variable costs Into the proper categories. And it takes both time and effort to do this.
Calculating your company's contribution margin is beneficial. It helps you make better business decisions. It lets you know what is making your profit and what is not. If the contribution margin is negative, then a product or a service should be eliminated. This means that your company is losing money each time that product is made. Knowing a product's contribution margin will allow you to focus on the products that make your company a profit. Think of calculating your company's contribution margin as a pruning process. You are getting rid of what is not working for your business. Why keep making a product or delivering a service that is not making our company any profit?
Mistakes can be made when calculating your company's contribution margin. You may make an error with fixed costs and variable class. This is a common mistake that business owners make when calculating their contribution margin If you are unsure how to do this task, consult with a financial expert. A financial expert will have the knowledge and expertise to do a contribution margin calculation for you. And it just may be worth your while to bring on an expert. This way, your business will be making more profit.
