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A financial term known as contribution margin (CM) calculates the amount of income that is left over after variable costs associated with creating and offering a good or service has been subtracted. CM is the portion of sales revenue that is not used to pay variable expenses; as a result, it helps to cover fixed costs and produce a profit. CM may be specified as a sum, a per-unit amount, or a percentage of sales income.
CM is one of the basic ideas in break-even analysis, a process that identifies the volume of sales or output necessary to cover all costs and generate no profit or loss. The break-even point (BEP), which is the point at which total revenue equals total costs, and the margin of safety (MOS), which is the gap between real sales and break-even sales, are both determined using CM. The degree of operational leverage (DOL), a measurement of how sensitive operating income is to fluctuations in sales revenue, is also determined using CM.
As it demonstrates how much income is available to cover the fixed costs and produces profits after paying for the variable costs, CM is a key measure of the profitability and efficiency of a business. CM is a crucial planning and decision-making tool because it enables managers to assess the effects of various pricing strategies, product mix, cost structures, and sales volume on the profitability and risk of the company.
The difficulties in identifying and separating fixed costs from variable costs, the assumption that costs and sales volume are linearly related, the disregard for the time value of money, and the unpredictability of future cash flows are just a few of the limitations and difficulties associated with CM. Additionally, there are some extensions and variations of CM, such as the contribution margin ratio (CMR), which measures the relationship between CM and sales revenue, and the contribution margin per unit (CMPU), which calculates the CM by the number of units sold, and the contribution margin income statement (CMIS), which is an accounting version of the income statement that combines fixed and variable costs.
