armember-membership domain was triggered too early. This is usually an indicator for some code in the plugin or theme running too early. Translations should be loaded at the init action or later. Please see Debugging in WordPress for more information. (This message was added in version 6.7.0.) in /home1/wanrru6iyyto/public_html/wp-includes/functions.php on line 6114ARMember domain was triggered too early. This is usually an indicator for some code in the plugin or theme running too early. Translations should be loaded at the init action or later. Please see Debugging in WordPress for more information. (This message was added in version 6.7.0.) in /home1/wanrru6iyyto/public_html/wp-includes/functions.php on line 6114Contribution margin is a core business concept and is often used in cost accounting<\/a><\/strong><\/span> to identify the amount of financial contribution a sold product provides to the company. Simply put, contribution margin is the sales price less the direct costs (sometimes referred to as variable costs).\u00a0 <\/span><\/span><\/p>\n A parallel reporting format is the top two sections of a profit and loss (income) statement<\/strong><\/span><\/a>. Sales less costs of goods sold equals\u2019 gross profit. Stated in a different way, price less variable costs equals contribution margin. However, in traditional accounting, the cost of goods sold<\/a><\/strong><\/span> section includes more than just the variable costs<\/a><\/strong><\/span> associated with the sale of the product. It is important for the reader to understand, contribution margin is a cost accounting concept; gross margin is a financial accounting concept. They are similar like cousins in a family; contribution margin is in the cost accounting family, gross margin is in the financial accounting family. Why is the term so important to understand? How is it calculated? Where is it most appropriately used? The following sections answer these questions and tie the concept of \u2018Contribution Margin\u2019 to business.<\/span><\/span><\/p>\n As a small business entrepreneur, you probably realize that there is more to business than just the sale of the product. There are a bunch of other costs to not only get the product to market but to run the business. There are monthly costs that never seem to stop, rent, utilities, communications, insurance, and office supplies. These types of costs are fixed in nature and don\u2019t stop even if you are unable to sell a product. Then there are other costs such as marketing, transportation of the product, labor to make and sell the product. There are supplies needed to package and deliver the product to the customer. Those costs directly related to the product itself, i.e. they would not exist without the product being delivered to the customer are known as variable costs.\u00a0 <\/span><\/span><\/p>\n The sales price less the variable costs is referred to as the contribution margin.\u00a0 <\/span><\/span><\/p>\n As an owner of a business, you don\u2019t make a profit until those fixed costs are paid first from the margin of the products sold. If you only sell one product a month, then the contribution margin, i.e. the dollars left over from the sales price less the costs of that product, has to cover all the fixed costs of your business. Believe it or not, this is true for many businesses. Shipyards for example sell one to five ships per year. They have to have enough contribution margin from the sale of a single ship to cover all the fixed costs at the yard.<\/span><\/span><\/p>\n This is why many people misunderstand car dealerships. The average person thinks that there is a lot of negotiating room in the price of the car because the dealer has a large markup on the car. Well, sure he does. He has to cover his fixed costs. Do you think his showroom rent is $500 per month? Your average small car dealership has between $25,000 and $100,000 per month in fixed costs. If he only sells 25 to 100 cars per month, then his contribution margin can be no less than $1,000 per car.\u00a0 <\/span><\/span><\/p>\n As a small business owner, you need to understand that the contribution margin covers your fixed costs and your desired profit. Now you need to figure out how to calculate the contribution margin in order to cover your fixed costs and desired profit.<\/span><\/span><\/p>\n As the type of product sold heads towards greater sales volume, the contribution margin for the product can decrease to cover the fixed costs in the company. If the contribution margin decreases, the price can decrease too and in turn, more sales occur. Let\u2019s do a simple equation to address a known item. Assume your fixed costs are $2,300 per month. The product (let\u2019s call this a widget) you sell costs 72 cents to purchase the product, pay for the labor to make the sale, and get the product delivered to the customer. How many widgets must you sell at $1.00 each to cover the fixed costs in one month? The formula is as follows:<\/span><\/span><\/p>\n \u00a0\u00a0 \u00a0N = Number of Widgets to Sell \u00a0Or in our case from above:<\/span><\/span><\/p>\n \u00a0Number of Widgets to Sell * Contribution Margin of (1.00-.72) 28 cents = $2,300<\/span><\/span>\u00a0<\/span><\/span><\/span><\/p>\n \u00a0 \u00a0 \u00a0 \u00a0 N*.28 = 2,300<\/span> Based on the above, we don\u2019t make a single dollar towards profit until we sell the 8,215th<\/sup> widget.<\/span><\/span><\/p>\n Let\u2019s keep this simple and calculate the contribution margin per widget sold.<\/span><\/span><\/p>\n We are operating a vending business and all we sell is bottles of soda. Our variable costs include the following:<\/span><\/span><\/p>\n 1.\u00a0\u00a0\u00a0\u00a0\u00a0 The cost of the bottle of soda For the sake of simplicity, assume the machines have no cost at all to the vending operation. A bottle of soda sells $1.50. Soda is purchased in volume and it is delivered to the business premises from the local distributing company at a cost of $.65 cents each. It costs around 18 cents per bottle to deliver the bottle to a machine (transportation costs). Furthermore, we use an automatic debit system at a cost of 1.82% to handle the money which is referred to as the discount fee. In effect, no machine takes coin or dollar bills; they are strictly modern debit\/credit card transactions only. Finally, a commission of 16 cents per dollar of net revenue (revenue less sales tax less the discount fee) is paid for labor. For the sake of simplicity, there is no employment tax or workman\u2019s compensation insurance for this example.<\/span><\/span><\/p>\n What are our variable costs?<\/span><\/span><\/p>\n Step One<\/strong>: Calculate the Sales Tax per Bottle of Soda \u2013 If a bottle of soda is sold at $1.50, then the sales tax variable cost equals $1.50 * 5%. This equals 7.5 cents per bottle. \u00a0 \u00a0 \u00a0 \u00a0\u00a0Cost per Bottle\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 $ .65
\n<\/span><\/span><\/p>\nUnderstanding Contribution Margin<\/span><\/strong><\/h2>\n
Contribution Margin Calculation<\/span><\/strong><\/h2>\n
\n<\/span>\u00a0 \u00a0 C = Contribution Margin per Widget
\n<\/span>\u00a0 \u00a0 F = Fixed Costs
\n<\/span>\u00a0\u00a0 \u00a0Formula:\u00a0 N*C = F<\/span><\/span><\/p>\n
\n<\/span><\/span>\u00a0 \u00a0 \u00a0 \u00a0 Therefore:\u00a0 N = 2,300.00\/.28
\n<\/span>\u00a0 \u00a0 \u00a0 \u00a0 N= 8,214 widgets<\/span><\/span><\/span><\/p>\n
\n<\/span>2.\u00a0\u00a0\u00a0\u00a0\u00a0 The cost to get that bottle delivered to the machine
\n<\/span>3.\u00a0\u00a0\u00a0\u00a0\u00a0 The cost of the labor to load the machine
\n<\/span>4.\u00a0\u00a0\u00a0\u00a0\u00a0 Since the consumer doesn\u2019t pay a sales tax, the tax state we provide services in requires our business to pay a 5% vending license tax on every dollar or revenue unadjusted for the sales tax. In effect every dollar is considered revenue.<\/span><\/span><\/p>\n
\n<\/span><\/span>Step Two<\/strong>: Determine the Discount Fee \u2013 the debit and credit card company charge a 1.82% fee on each dollar of sales or $1.50 * .0182 or 2.73 cents per bottle
\n<\/span><\/span>Step Three<\/strong>: Labor to Load a Machine \u2013 Commission is 16 per cent of net revenue. Net revenue equals the total sales price less the vending tax of 7.5 cents less the credit card discount fee of 2.73 cents or ($1.50 – .075 – .0273) $1.3977 per bottle. Since net revenue is $1.3977; labor at 16% of net = 22.36 cents per bottle
\n<\/span><\/span>Step Four<\/strong>: Add up the Variable Costs:<\/span><\/span><\/span><\/p>\n
\n<\/span><\/span>\u00a0 \u00a0 \u00a0 \u00a0\u00a0Transportation per Bottle \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0.18
\n<\/span>\u00a0 \u00a0 \u00a0 \u00a0\u00a0Labor \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 .2236
\n<\/span>\u00a0 \u00a0 \u00a0 \u00a0\u00a0Sales Tax\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0\u00a0 .075
\n<\/span>\u00a0 \u00a0 \u00a0 \u00a0\u00a0Discount Fee\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0\u00a0 .0273
\n<\/span><\/span>\u00a0 \u00a0 \u00a0 \u00a0 Total Cost per Bottle\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$1.1559<\/span><\/span><\/span><\/p>\n