Question

1. Explain the concept of a contribution margin and describe how it differs from gross margin. Also, what is the significance of the contribution margin ratio, and how is the ratio useful in planning business operations?  Provide examples.

Answer 1

Contribution margin is the ratio which arrives after reducing all the variable costs from sales revenue.

Where the gross margin only consider cost of goods sold instead of variables expenses.In the concept of gross margin only cost of goods sold is considered and variable selling and admin cost is not considered as a part of cost of goods sold.However while calculating contribution margin all the variable cost are considered.

The main difference in both is only base which is reduced from the sales revenue.

Contribution margin ratio is important in various cost and benefit analysis.The contribution margin is highly used in decision making for any specific order and for any make or buy decision.

Following are the scenario where contimribution margin is used-

Break even point

Margin of safety sale

Calculation of target profits

In an overall analysis it can be said that for the business analysis and planning for future production,sale, finances etc,this ratio becomes very important.

A business can increase it's fixed expenses and other variable expenses based on existing contribution margin.This ratio will tell the firms that how much units is required to be at a situation, where firm earns no profit and no loss.

Thats it,

Please comment for any explanation,

Thanks