Author: Sarthak Bhalerao
Table of Contents
- What is Contribution Analysis?
- Contribution Margin Formula and Example
- Pros and Cons of Contribution Analysis
What is Contribution Analysis?
Contribution analysis is used in estimating how direct and variable costs of a product affect the net income of a company. Contribution Analysis addresses the issue of identifying simple or overhead costs related to several production projects. Contribution analysis aids a company evaluate individual business lines or products and their performance by comparing their contribution margin dollars and percentage. Direct and variable costs incurred during the manufacturing process are subtracted from revenue to arrive at the contribution margin. This is a very crucial tool for managing the growth of any business.
Contribution Margin Formula and Example
The formula for Contribution Margin dollars per unit is:
Contribution Margin = (Total revenue – variable costs) / No. of units sold
A company sells 10,000 shoes for total revenue of $500,000, with a cost of goods sold of $250,000 and a shipping and labor expense of $200,000.
The contribution margin per shoe is ($500,000 – $250,000 – $200,000) / 10,000
Contribution = $5.00 per shoe
Pros and Cons of Contribution Analysis
Contribution analysis helps in comparing how individual products are profitable to the company and is easy to use. The significance of contribution analysis is that it indicates the profitability of each product and helps you understand the various components and specific external and internal factors that influence a company’s income, and it utilizes existing information.
- The sales price remain constant as no discounts are given.
- The product cost is linear
- There is no inventory as what s produced is sold immediately.