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Both gross margin and contribution margin are valuable concepts for cost managers, but they communicate different information. Gross margin is the difference between revenues and cost of goods sold; in other words, gross margin is a measure of how much the company charges above the cost of its products. Gross margin shows how much money is available to cover non-manufacturing costs. Contribution margin, on the other hand, is the difference between revenues and all variable costs. This shows how much money is available to cover fixed costs. Fixed costs by definition cannot be altered in the short run, and contribution margin can be used to determine the minimum sales volume to cover these fixed costs. Contribution margin can be used to answer questions like: How much do we have to sell to break even? How much do we have to sell to cover this new fixed-cost investment? At what volume of sales will we make our target income? (Datar, S.M., & Rajan, M.V., 2018, p. 88). It seems to me that contribution margin is more significant for use in CVP than gross margin. Cost-Volume-Profit Analysis is about determining costs and profits at various levels of production; its focus is on the effect of variable costs on profitability. Contribution margin isolates variable costs from fixed costs, while gross margin mixes variable and fixed costs together in the form of Cost of Goods Sold. This in effect makes it more difficult to see the results of changes in variable costs due to volume

Answer 1

CVP stands for Cost, Volume, Profit analysis. In simple terms it is the analysis of cost and profit for a particular volume of product. Weightage should be given on the term cost. In contribution margin, cost is either variable or fixed. It is a more holistic approach. Variable and fixed costs includes all type of cost irrespective of the fact that they are manufacturing or non manufacturing. Contribution margin is arrived after deducting total variable costs from the revenue unlike Gross margin which is arrived after deducting all type of manufacturing costs and overheads (fixed or variable) from the revenue. So decision taken under contribution margin method are more accurate and close to reality. It does not distinguishes between company's expenditure on various departments and the net income arrived under this method represents the global income of the company. Unlike gross margin method where step down method is used to arrive at departmental profits first and then the global profit of the company at last. Contribution margin method assumes that all the outflows of the company from production of goods to dispatch to the consumers are cost to the company in that particular year. It is a more realistic approach than carrying forward the costs (manufacturing and non manufacturing overheads) under Gross margin method. That is why we can say that contribution margin is a better approach for CVP analysis than gross margin.