If you want to increase the profitability of your business in the fastest way possible, then you have to analyze the total contribution margin at the break-even point of your business properly. The contribution margin is a management accounting calculation. When you analyze your contribution margin properly, you would be able to understand the contribution margin of your business and this will definitely help you to do more than just break even. Today in this article we will guide you to do more than just break even the contribution margin of your business. Read the article till the end. This will make sure that you completely know how to do more than just break even with the help of contribution margin.
What is Contribution Margin At The Break-Even Point
The amount of revenue left after deducting the variable cost from the total revenue is known as the “Contribution Margin”. The Contribution Margin can be mathematically represented by
Revenue – Variable Costs = Contribution Margin
It can also be defined as the amount left after deducting the “Variable overhead expenses” from the “Gross profit margin”. The Break-even of a business is reached when Contribution margin dollars become equal to the fixed costs dollars. You can earn profit in your business when the Contribution margin dollars becomes more than the fixed costs dollars. You must make sure that the expenses of your business are separated into two different parts namely, “Variable costs” and “Fixed costs”. This will help you to calculate the contribution margin of your business.
Why Should You Know Your Business’ Contribution Margin
The contribution margin will help you to look at the breakdown of the money that comes into your business and will show you how much of that amount is contributing to overhead payment and earning profit for the business. You can calculate the break-even point with the help of the profit you earned in your business. The Break-even point can be mathematically represented as
Fixed cost / Contribution Margin = Break Even point
When the Contribution margin dollars becomes equal to the fixed costs it is known as the break-even point. In other words, we can say that at the break-even point there is no extra money left to earn a profit, and you want to get ideas to earn extra money in your business and to generate free cash flow in your business.
Gross Profit Percentage Vs Contribution Margin
The gross profit will generate your net income. When you increase the Gross Profit of your business, the extra amount of money will be collected in your bank account. If you calculate the Gross profit percentage of your business, it will help you to get a complete overview of the profitability of your business, and thus you can increase the profitability of your business. The most important difference between the Gross profit margin and the Contribution margin is the “Variable Cost”.
The Gross profit percentage will give you a complete overview of the effectiveness of your business. It will guide you to price your items perfectly to run your business smoothly.
The contribution margin and gross profit margin are both different from each other. Both can be represented as dollars as well as in percentages. Dollars and percentages give different information about your business.
Gross profit margin can be mathematically represented as
Revenue – Cost of Goods Sold = Gross Profit Margin
The indirect or overhead expenses that are variable can also be represented as the difference between “Gross profit margin” and “Contribution margin”. In order to know the break-even point, you have to deduct the “Below line costs” that are variable.
What is “Below the Line Cost”?
The overhead costs are also known as “Below the Line Cost”. These costs are not directly paid by your customers. Therefore these costs are also known as indirect costs. These costs are not above the line because these costs are not directly paid by the customers. These costs include accounting and IT costs, legal and facility costs, marketing and selling expenses, etc.
The main purpose of the break-even point is to cover the fixed costs of your business. When you add a new customer, you have to deduct the commission from the gross profit in order to determine the break-even point of your business.
The most common example of these costs is Sales commission.
How The Profitability of Your Business Can be Increased
In order to increase the profitability or get back to the break-even point of your business, you can use these methods, which are
- By increasing the Contribution margin
- And by cutting your fixed costs
- By increasing productivity according to the demand.
Methods to Increase the Contribution margin
There are two methods to increase the contribution margin of your business. Let us have a look at those two methods
- Finding Time Leakage
The time that you are investing in your business, but are not charging the customers for that time is known as Time leakage. This means that you are wasting a part of your time because you are not getting paid for that time. Finding time leakage is the best method to increase the contribution margin of your business.
In order to manage this time leakage, you have to increase the billings and you have to compare the actual costs of each job to the budget for that job. You have to show your customers the service they are getting but not paying for that service. The customers will happily pay you if they are happy with your service and if you explain to them the value that they’re getting for the additional billings.
If you want to get paid for the value of the work you do, them
- You have to increase the price in order to show the value of the work you do.
- Help them to stay on budget by decreasing the scope.
- To make a transition of the clients to another service provider.
Thus you can increase the billing to manage the time leakage. This will definitely help you to get back to the break-even point and earn more profit for your business.
- Adjusting Your Pricing Strategy
The contribution margin can also be increased by pricing the new jobs properly. You have to make decisions based on the data collected to set the price of the items properly so that you can earn more profit and increase the contribution margin to pay its share of overhead.
If you want to price your items perfectly, then you have to do a complete review of the above-the-line costs which will definitely help you to price the items perfectly. You must make sure that the “Above the line costs” and the “Below the line costs” are separated properly. You have to follow the below-mentioned steps in order to separate the “Above the line costs” and the “Below the line costs”
- First of all, you have to separate your chart of accounts in order to track the “Above the line costs” and the “Below the line costs”.
- Determine which people are above the line and which people are below the line.
- Then while running the payroll you have to determine the labor cost of your people.
- Do a complete review of the profits and losses of each department to find out any opportunity for the growth of your business.
- Track, and calculate the overhead cost of your business.
- Focus on the lowest-performing department to increase the profitability of your business.
We hope that now you completely know that you should know the total contribution margin at the break-even point of your business in order to make data-based decisions that will help you to cut to break even. The guidance provided in this article will definitely help you to know how to do more than just break even with the help of a Contribution Margin. You should always keep in mind the methods to increase the contribution margin of your business. We recommend you read the entire article without skipping a single point in order to know how to do more than just break even with the help of contribution margin.
Is the contribution margin the same as the break-even points?
No, the Contribution margin is not the same as the break-even point. If you talk about the contribution margin then you want to determine, how much your business will generate profit from each product, contribution per unit is the selling price per unit less the variable cost per unit while the break-even point is the total of how much your business generates revenue to cover the cost and expenses of your business. Break-even points show the total profit of your business is zero which means your cost is equal to your profit.
What if break-even is negative?
If any organization shows its break-even point as negative then it presents the organization’s financial health as not good which means the business is operating at loss. They were not performed well and fail to generate revenue that covers the total cost.
What does it means contribution margin goes negative?
The contribution margin generally refers to how much revenue is generated against the cost occur on producing each product. So, if the contribution margin is zero then it shows that your cost incur on producing each unit is higher than the revenue generated by each product. This situation would be an alarming situation for your business to make a pricing strategy or discontinue your product.
What is the contribution margin ratio?
The contribution margin ratio shows the marginal benefits of producing one extra unit of product that can be calculated by the formula: CM Ratio = Total Revenue – Variable Cost divided by Total Revenue. Never include the fixed cost in this formula but you have to consider that your CM margin dollar (Total revenue – Variable cost)should be more than the Fixed cost.
Is the contribution margin is same as the net profit?
The answer is simple ‘No’, if you calculate your business net profit then you are going to include the total cost in the calculation which is a variable cost and fixed cost. The formula for calculating net profit is Total Revenue – Total cost. But if you talk about the contribution margin then it excludes the fixed cost, which refers to how much cost you bear to produce one extra unit of product.