Contribution margin ratio

Contribution margin ratio

by Milena Ackovic

​Today’s Learning Objectives

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• distinguish between contribution and contribution margin ratio

• interpret margins of safety

• finding level of output in order to reach profit​

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​What is contribution margin ratio

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The bottom part of the break-even formula (selling price per unit less variable cost per unit) is known as the contribution per unit.

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It is called ‘contribution’ because indicates how a particular product contributes to the overall profit of the company and shows the portion of sales that helps to cover the company's fixed costs. ​

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Any remaining revenue left after covering fixed costs is the profit generated. It is good to have a high contribution margin ratio, as the higher the ratio, company is available to cover all the expenses.

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​Formula for contribution margin ratio

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​​The contribution margin ratio is the contribution from an activity expressed as a percentage of the sales revenue.

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Contribution and sales revenue can both be expressed in per-unit or total terms.

​Margin of safety

​A margin of safety (MoS) is a difference between actual sales and level of breakeven sales. MOS is everytime we have excess of sales over break even.

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​Managers can utilize the margin of safety to know how much sales can decrease before the company or a project becomes unprofitable.

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This amount tells us how much sales can drop before we show a loss. A higher margin of safety is good.

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​Example of Margin of safety

​If, Minnesota Kayak Company needs to sell 28 kayaks at $500 each to break even. So in this example, $14,000 in sales is their break even point.

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Let’s assume their current sales of kayaks is 50 kayaks per month at $500 each, so $25,000. Using the formulas above, what is their margin of safety?

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$25,000−$14,000=$11,000$ is their margin of safety.

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What is their margin of safety percentage?

$11,000/$25,000=44% is their margin of safety percentage.

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Company can sell 44% fewer dollars worth of kayaks and still break even.

​Finding level of output to reach profit

To find preferable profit for the company, use the formula for break even point and add profit to the fixed costs

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BEP= fixed cost + profit / contribution

= fixed cost + profit / selling price -variable cost per unit​

Some text here about the topic of discussion

Multiple Choice

What is contribution margin rate?

• rate that shows how much each product contribute to the overall profit of the company

• rate that is measuring how much sales can decrease and still be in break even

• rate that measure cost of making one extra unit

• rate that is measuring level of production where we dont have even profit even loss

Multiple Choice

What is the margin of safety?

• the difference between projected sale and break even sale

• the margin between profit and loss

• the margin between units and sales

• the margin between each break even point

  HIDE ANSWER

Multiple Choice

If fixed costs are 21800, targeting profit 145000, selling price per unit 6.99, variable costs per unit 0.24. How many units must be sold to reach this profit?

• 24.711

• 30 000

• 500

• Can't be calculated

Multiple Choice

If your total sales are 2000$ and total variable costs are 800$, how much is contribution margin ratio?

• 60%

• 40%

• 50%

• 10