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May 05, 2022

What is the Contribution Margin Income Statement?

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Various income statement formats can help a company differentiate its profit and loss over a given period. The margin income statement converts the traditional income statement format and replaces specific total lines with margins rather than a profit summary. For instance, this type of income statement includes the gross contribution margin, the contribution margin, and final operating income for the period. An income statement in margin contribution format may be best suited for manufacturers.

Contribution Margin Income Statement explanation

The Contribution Margin Income Statement is a table that reflects the revenue of a business and the expenses it incurred to earn it. The difference between them is profit or loss if it has a negative value. The Contribution Margin Income Statement likewise reflects the critical performance indicators of the business as a whole and its areas, if there are several of them.

The most significant difference in the income statement in marginal profit format is the split of certain expenses. The first section, for instance, has a row for sales and variable expenses. The distinction between the two — sales revenue minus variable expenses — results in a contribution margin applied to the rest of the expense in the business. While the traditional margin statement uses dollars as values, a company can prepare a report with percentages. A different look can help a company create a trend analysis for its financial statements.

In the second part of this statement, the section includes the company’s specific expenses for a particular period. The company usually has a non-manufacturing variable cost — the difference between these expenses and the gross margin results. The first two types of expenses are inconsistent because they can change depending on the company’s production volume. It is perhaps the essential part of the income statement in marginal earnings format.

Why is the Contribution Margin Income Statement required?

The Contribution Margin Income Statement answers the central question: what is the business’s net profit, and how much did it earn. And the procedure based on which it is compiled allows you to calculate it accurately. You need to know your profit so as not to pull too much out of business and have a reason for analyzing what can be done if it is insufficient.

Contribution Margin Income Statement helps to calculate:

  • marginality;
  • profitability;
  • the break-even point of the entire business and individual areas.

These indicators are needed to manage profits.

Marginality is the ratio of profit and price. It shows the proportion of profit to revenue. The higher the margin percentage, the better. When the owner knows the margin, he has a reason to think about whether it is possible to increase it and at what expense.

What is the Contribution Margin Income Statement?

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Margin approach

The use of various cost accounting methods affects the value of the cost of production and the income statement form. Under the marginal profit approach and the variable cost approach, a new form of the income statement can be developed that shows the variability of costs and the product’s contribution to profit. With the marginal approach, prices are not divided into production and non-production; attention is focused on separating variable and fixed costs.

Variable costing methods and the marginal approach are most commonly used in short-term decision making, such as whether to replace or keep old equipment, accept or reject a particular order, make or buy components, and determine product mix in resource-constrained environments.

Profit Margin Statement

The traditional income statement for external use classifies costs by functional basis, i.e., production and non-production. An alternative income statement is known as a contribution margin statement. It ranks costs behaviorally, regardless of the function corresponding to the charges, and reflects the interaction of variable and fixed costs.

The profit margin approach provides managers with helpful information for planning and decision-making. The profit margin statement highlights marginal profit — the difference between sales and variable costs. The traditional report calculates gross profit — the difference between revenue and cost of sales.

Gross profit

The primary financial document of the enterprise, the profit and loss statement, begins with «gross revenue», i.e., the volume of goods sold by the enterprise for the reporting period, expressed in cash at sales prices, which, in turn, were specified in contracts concluded by the enterprise with buyers and customers, or in price tags for products, if these are retail sales. We get the gross profit by subtracting the cost of the selling products from the gross proceeds.

There are quite a lot of varieties of profit. One of the answers to the question «Why are there so many of them?» is the following: «To share». What does it mean to share profits? The fact is that profit is a direct financial assessment of the result achieved by the enterprise as a whole or by its divisions during the reporting period. Consequently, it is quite natural that the question arises of rewarding, in addition to wages, the enterprise’s employees who are directly involved in achieving the financial result, in the form of a percentage of the profits received.

Wrapping Up

With the help of the Contribution Margin Income Statement, the owner manages profit by analyzing what can be done to increase it, evaluating costs for efficiency, and so on. When a business has several directions, Contribution Margin Income Statement allows you to compare how effective they are to identify those that eat into the overall profit. Consequently, yield is calculated for each when a business has several directions. It allows you to evaluate their effectiveness. If at least one direction is unprofitable, the owners lose part of the profit that others bring. Knowing the result of each direction, we identify in time those that are pulling to the bottom. And they get a reason to think about what to do with them: is it possible to withdraw profit, or is it easier to close.

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Author: Charles Lutwidge

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