Contribution Margin and Breakeven Analysis Simulation Managerial Accounting and Finance Foundations – FIN 540

Essay by carno01 January 2009

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IntroductionToday's business leaders are under enormous pressure to grow revenues, increase profits and expand the value of the business. Rather than focus on profit improvement, owners and managers should focus on improving underlying business activities and processes such as sales, production and distribution. In order to determine whether a business decision will improve profitability, you first must understand how costs are defined, as well as the relationship between cost, volume, and profitability. One of the important, yet relatively simple, tools afforded by cost/volume/profit analysis is known as contribution margin analysis. Your company's contribution margin is simply the percentage of each sales dollar that remains after the variable costs are subtracted. When you know the contribution margin, you can make better decisions about whether to add or subtract a product line, about how to price the product or service, and about how to structure any sales commissions or bonuses. (Business Owner's Toolkits,2005).

Optimizing ProfitsEvery business needs to cover its costs in order to make a profit. Working out the costs accurately is an essential part of working out the pricing. A business incurs fixed costs and variable costs. Fixed costs are those that are always there, regardless of how much or how little you sell, for example rent, salaries and business rates. They remain constant even if the activity level changes. Fixed costs are the costs of the investment goods used by the firm, on the idea that these reflect a long-term commitment that can be recovered only by wearing them out in the production of goods and services for sale. On the other hand, variable costs are those that rise as your sales increase, such as additional raw materials, extra labor and transport. When you set a price, it must be higher than the variable cost of producing your...