Question

How is the contribution margin concept different from the gross profit concept and why is the distinction important? Why would a company endeavor to calculate these amounts for their products?

While not mandatory for credit, I highly encourage you to read your classmates thoughts and comment on their reflections. You may be able to help each other! I will be reading your discussions and commenting both on the board itself and on the grading screen.

Answer 1

Solution:-

Contribution Margin

Contribution margin is the revenue remaining after subtracting the variable costs that go into producing a product.Contribution margin shows you the aggregate amount of revenue available after variable costs to cover fixed expenses and provide profit to the company.

Contributuion Margin = [(Revenue - Variable Costs)/Revenue]*100

For Instance: Price of your Product is $100 and the Variable Cost of your product is $70, Then Contribution margin will be [($100-$70)/$100]*100 = 30%

Gross Profit

Gross profit is the revenue remaining after subtractiing direct production cost from revenue.Gross profit shows you the aggregate amount of revenue available after direct production costs to cover operating, administration, marketing expenses and other items such as Taxes, Interest on loan etc.

Gross Profit = Revenue - COGS

Gross Profit Margin = [(Revenue - COGS)/Revenue]*100

Here, COGS means Direct Production Costs which includes Opening Inventory+Direct Material Costs+Direct labour Costs-Closing Inventory

COGS is known as Cost of Goods Sold

For Instance: The revenue of Company A is $20,000 and the COGS of Company A is $17,500, Then Gross Profit will be $20,000-$17,500 = $2,500 and Gross Profit Margin Will be [$2,500/$20,000]*100 = 12.5%

Why the distinction is important ?

Since, Contribution margin is per product profit metric while Gross profit is entire company's profitability after subtracting costs directly linked to production from revenue.

Why company endeavor to calculate these amounts ?

Contribution Margin :- Analyzing the contribution margin helps managers to make several types of decisions, from whether to add or subtract a product line. The most common use is to compare products and determine which product to continue and which product should be discontinued. If a product’s contribution margin is negative, the company is losing money with each unit it produces, and it should either drop the product or increase prices.

Gross Profit :- The two most crucial inferences that can be drawn from the gross profit are

i) The value of resources a company is utilising behind the production.

ii) The scale of revenue it can generate against such resources

Gross profit assesses a company's efficiency at using its labour and supplies in producing goods or services. The metric mostly considers variable costs that is, costs that fluctuate with the level of output.