Budgeting Basics and Beyond

4.4. Some Applications of Contribution Margin Analysis and "What-If" Analysis

The concepts of contribution margin and the contribution income statement have many applications in profit planning and short -term decision making. Many "what-if" scenarios can be evaluated using them as planning tools, especially utilizing a spreadsheet program. Some applications are illustrated in Examples 6 to 10 using the same data as in Example 1.

Example 6

Recall from Example 1 that Flip Toy Store has a CM of 60 percent and fixed costs of $15,000 per period. Assume that the company expects sales to go up by $10,000 for the next period. How much will income increase?

Using the CM concepts, we can quickly compute the impact of a change in sales on profits. The formula for computing the impact is:

Change in net income = Dollar change in sales × CM ratio

Thus:

Increase in net income = $10,000 × 60% = $6,000

Therefore, the income will go up by $6,000, assuming there is no change in fixed costs.

If we are given a change in unit sales instead of dollars, then the formula becomes:

Change in net income = Change in unit sales × Unit CM

Example 7

Assume that the store expects sales to go up by 400 units. How much will income increase? From Example 1, the company's unit CM is $15. Again, assuming there is no change in fixed costs, the income will increase by $6,000.

400 units × $15 = $6,000

Example 8

What net income is expected on sales of $47,500?

The answer is the difference between the CM and the fixed ...