Contribution margin, or total revenues minus variable costs, is a critical calculation that helps a business owner discover the company's break-even point, which is the point at which a company becomes profitable. It can also help a manager decide whether and how to modify production costs and/or unit pricing. As sales revenues decline, if variable costs remain constant, the contribution margin will also decline.
1. Find out the sales revenue figure for the period of declining sales. For example, assume the revenue figure is $100,000, down from $150,000 the previous year.
2. Get the variable cost figure for the same period. Continuing with the example from the previous step, the variable cost figure will be $60,000. The assumption will be that variable costs have remained constant year over year.
3. Calculate the contribution margin for the period of declining sales. To begin with the previous year's calculation, $150,000 minus $60,000 equals $90,000, which is the contribution margin. For the period of declining sales, the calculation is $100,000 minus $60,000 to arrive at a contribution margin of $40,000.
- You can calculate the contribution margin for more limited periods, such as three months or six months. Getting a more granular perspective can be especially constructive as you analyze a period of declining sales.
Items you will need
- Revenue and variable cost data
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