Contribution margin (CM), or dollar contribution per unit, is the selling price per unit minus the variable cost per unit. "Contribution" represents the portion of sales revenue that is not consumed by variable costs and so contributes to the coverage of fixed costs. This concept is one of the key building blocks of break-even analysis.
thumb|right|240px|Decomposing Sales as Contribution plus [[Variable Costs. In the Cost-Volume-Profit Analysis model, costs are linear in volume.]]
In cost-volume-profit analysis, a form of management accounting, contribution margin—the marginal profit per unit sale—is a useful quantity in carrying out various calculations, and can be used as a measure of operating leverage. Typically, low contribution margins are prevalent in the labor-intensive service sector while high contribution margins are prevalent in the capital-intensive industrial sector.
Purpose
In Cost-Volume-Profit Analysis, where it simplifies calculation of net income and, especially, break-even analysis.
Given the contribution margin, a manager can easily compute breakeven and target income sales, and make better decisions about whether to add or subtract a product line, about how to price a product or service, and about how to structure sales commissions or bonuses.
Contribution margin analysis is a measure of operating leverage; it measures how growth in sales translates to growth in profits.
The contribution margin is computed by using a contribution income statement, a management accounting version of the income statement that has been reformatted to group together a business's fixed and variable costs.
Contribution is different from gross margin in that a contribution calculation seeks to separate out variable costs (included in the contribution calculation) from fixed costs (not included in the contribution calculation) on the basis of economic analysis of the nature of the expense, whereas gross margin is determined using accounting standards. Calculating the contribution margin is an excellent tool for managers to help determine whether to keep or drop certain aspects of the business. For example, a production line with positive contribution margin should be kept even if it causes negative total profit, when the contribution margin offsets part of the fixed cost. However, it should be dropped if contribution margin is negative because the company would suffer from every unit it produces.
The contribution margin analysis is also applicable when the tax authority performs tax investigations, by identifying target interviewees who have unusually high contribution margin ratios compared to other companies in the same industry.
Contribution margin is also one of the factors to judge whether a company has monopoly power in competition law, such as use of the Lerner index test.
Contribution
The Unit Contribution Margin (C) is Unit Revenue (Price, P) minus Unit Variable Cost (V):
:<math>C = P - V</math>
! 0
! 1
! 2
|-
| Excess staffing costs
| > 10%
| 5-10%
| < 5%
|-
| Start-time tardiness (mean tardiness for elective cases/day)
| > 60 min
| 45–60 min
| < 45 min
|-
| Case cancellation rate
| > 10%
| 5–10%
| < 5%
|-
| Post Anesthesia Care Unit (PACU) admission delays (% workdays with at least one delay in PACU admission)
| > 20%
| 10–20%
| < 10%
|-
| Contribution Margin (mean) per operating room hour
| < $1,000/h
| $1–2,000/h
| > $2,000/h
|-
| Operating room turnover time (mean setup and cleanup turnover times for all cases)
| > 40 min
| 25-40 min
| < 25 min
|-
| Prediction bias (bias in case duration estimates per 8 hours of operating room time)
| > 15 min
| 5–15 min
| < 5 min
|-
| Prolonged turnovers (%turnovers > 60 min)
| > 25%
| 10–25%
| < 10%
|}
A surgical suite can schedule itself efficiently but fail to have a positive contribution margin if many surgeons are slow, use too many instruments or expensive implants, etc. These are all measured by the contribution margin per OR hour. The contribution margin per hour of OR time is the hospital revenue generated by a surgical case, less all the hospitalization variable labor and supply costs. Variable costs, such as implants, vary directly with the volume of cases performed.
This is because fee-for-service hospitals have a positive contribution margin for almost all elective cases mostly due to a large percentage of OR costs being fixed. For USA hospitals not on a fixed annual budget, contribution margin per OR hour averages one to two thousand USD per OR hour.
See also
- Break-even (economics)
- Cost–volume–profit analysis
- Gross margin
References
Other sources
- Cost-Volume-Profit Analysis; Chapter 11 at MAAW
- Cost-Volume-Profit Analysis at CliffNotes
- Cost-Volume-Profit Analysis at Answers.com
External links
- MASB Official Website
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