Contribution Analysis

Good Essays

Laticia G. Josiah
Finance 540
“Contribution Margin and Break Even Analysis” Simulation
Prof. Richard Franchetti
April 6, 2005

The ultimate goal of any firm is to generate profit. Steve Lefever states that there are two ways to generate profit: you can simply go from day to day and hope it happens or, you can identify the primary “drivers” of profitability and manage them. It is important for managers to manage how the sales dollars flow through the firm. Break-even analysis can help a firm make significantly better decisions for the future. This analysis is a very useful and effective method of assessing cost volume profit relationship. “The Contribution Margin and Break Even Analysis” simulation requires maximization of …show more content…

This allows Maria to meet the exact sales target for the month and earn an overall operating profit. If the break-even point for the new facility increases to 650,000 packs instead of 535,000 packs, the existing facility would be forces to reduce volume as producing at maximum capacity would exceed the monthly production target. The increase in the break-even point means that there will also be increase in variable costs. Although Maria would still be making a profit, she would not be maximizing her profit making ability. Since the contribution margin still allows fix cost to be covered, leaving the firm with a profit, Maria should still purchase the plant. From doing the simulation, the three main learning points that attracted my attention were the contribution margin, break- even analysis and variable costs. Throughout the paper, I have explained the importance of the contribution margin and the break-even analysis. Identifying your break-even sales volume begins with the proper division of operating costs into either fixed or variable costs. Fixed costs hold constant across a specific range of sales but variable costs fluctuate proportionately with any change in sales. The contribution margin from each sale becomes the critical third element that enters into the calculation of the break-even sales volume. The contribution margin represents the difference between the sales price and the

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