Contribution

The term contribution refers to the excess of selling price over a product’s variable cost. Thus, contribution is the difference between the sale price and variable cost. In other words:

Contribution (C) = Sales – Variable cost (or Fixed cost) + Profit

Example

Suppose that sales are $80,000, variable cost is $40,000, and fixed cost amounts to $30,000. Using this information to calculate contribution, it follows that:

Contribution = Sales – Variable cost
= $80,000 – $40,000
= $40,000

Usefulness of Contribution

Contribution is useful for a company’s management in the following ways:

1. When calculating BEP: At the break-even point (BEP), sales values and total costs are equal. Excess output over BEP output will result in profit.

2. Provides information about desired profit: Profit happens when the contribution exceeds the fixed costs. The amount of profit that a company aims to earn depends on its cost of capital.

The BEP is a no-profit no-loss area, where the desired profit is represented as an addition over the BEP.

To calculate profit based on contribution and fixed costs, the formula is:

Profit = Contribution – Fixed costs

3. Selection of best alternative: The concept of contribution helps to evaluate alternative proposals (e.g., whether to change the sales mix or enter an overseas market).

Break-Even Point (BEP)

The break-even point, or BEP, is the point at which the cost incurred and the revenues generated are equal. It is also known as zero-point costs. Excess output and sales over BEP is an indicator of profit.

The formula for BEP is as follows:

BEP sales = Fixed expenses + Variable costs

BEP in units: Fixed expenses $80,000 sale price per unit $20, variable cost $15. Thus BEP (Units)

BEP= Fixed expenses / C
= 80,000 / 5
= 16,000 units

Verification

Sales value = 16,000 units x 20 $320,000
Variable cost = 16,000 x 15 240,000
Fixed cost 80,000
Total cost 320,000
(0) Zero

BEP (Sales) = BEP units x Per unit sale
= 16,000 x 20
= $320,000

Usefulness of Break-Even Point (BEP)

The break-even point (BEP) is used in the following main ways:

1. Knowledge of profitability: The BEP offers information about the profitability of specific products.

2. Helpful in changing sales price: The BEP is useful in changing sales price and its effects on business.

3. Desired profit: The BEP is useful in knowing the amount of desired profits.

4. Useful for expansion: The BEP is helpful in learning about the expansion possibilities of the business.

5. Useful for knowledge about profit or loss on different levels of output: BEP provides clear data about profit and loss. When sales exceed the BEP, profit is possible; when sales are lower than the BEP sales, losses are probable.

Frequently Asked Questions

What is the excess of total sales over sales at BEP?

The excess of total sales over sales at bep is referred to as contribution. for example, let us consider a company where sales amount to $80,000 and variable cost is $40,000. in this case, contribution which refers to the difference between the sale price and variable cost will be $40,000. it can therefore be said that contribution is the difference between the sale price and variable cost.

What is the Break-Even Point (BEP)?

Break-even point (BEP) depends on whether we are discussing the number of units required, or total revenues required to cover total costs. BEP is the point at which total costs equal total revenues. If a company has fixed costs (e.g. rent, insurance), the number of units must be large enough to cover these fixed costs before it can make any profit or loss. Once fixed costs are covered, then consideration should be given to whether there are still more units that could be sold.

How can the break-even point be determined?

It is the point at which total costs equal total revenues. In terms of units, it means that you must sell enough units to cover your variable costs and fixed expenses.

What is the break-even point (BEP)?

Break-Even Point: The sales volume level at which total annual revenue (TR) equals total annual cost (TC). If the sales volume is less than breakeven, then we have a loss; if sales exceed this BEP, then we have profit.

What is the excess of total sales over sales at BEP called?

The excess of total sales over sales at bep is referred to as contribution. for example, let us consider a company where sales amount to $80,000 and variable cost is $40,000. in this case, contribution which refers to the difference between the sale price and variable cost will be $40,000. it can therefore be said that contribution is the difference between the sale price and variable cost.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

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