Question

Explain how Contribution Margin Analysis is useful for managerial decisions and performance evaluations.

Answer 1

A Contribution margin analysis is an analysis which helps in understanding the cost structure and profitability of the income statement. The difference between Sales and Variable cost is Contribution It is a managerial tool and technique regularly used for internal decision making by management. It is useful in following ways

• It helps in understanding cost structure of products, divisions, etc. Cost is classified into variable cost and fixed cost. Variable cost varies at different level of activity and fixed cost remains same .
• It helps in profitability evaluation. The difference sales and variable cost that is Contribution helps in recovering fixed cost and checking profitability at different levels of activity
• It helps in Break-even analysis. Break-even point is the point at which there is no profit or loss. In other words Contribution is equal to fixed cost
• It helps in taking various decisions like – product pricing, division analysis, make vs buy, shutdown vs continue, etc
• It helps the firm in Cost management through cost control and cost reduction. It helps in target costing by deciding the cost of products