Budgeting Basics and Beyond

4.7. Conclusion

Break-even and contribution margin analysis is useful as a frame of reference, as a vehicle for expressing overall managerial performance, and as a planning device via break-even techniques and "what-if" scenarios.

The next points highlight the analytical usefulness of contribution margin analysis as a tool for profit planning:

• A change in either the selling price or the variable cost per unit alters CM or the CM ratio and thus the break -even point.

• As sales exceed the break-even point, a higher unit CM or CM ratio will result in greater profits than a small unit CM or CM ratio.

• The lower the break-even sales, the less risky the business and the safer the investment, other things being equal.

• A large margin of safety means lower operating risk since a large decrease in sales can occur before losses are experienced.

• Using the contribution income statement model and a spreadsheet program, such as Excel, a variety of "what-if" planning and decision scenarios can be evaluated.

• In a multiproduct firm, sales mix is often more important than overall market share. The emphasis on high -margin products tends to maximize overall profits of the firm.

We discussed how the traditional contribution analysis can be applied to the profit and nonprofit setting. Illustrations were provided. Managers can prepare the income statement in a contribution format, which organizes costs by behavior rather than by the functions of manufacturing, sales, and administration. The contribution income ...