What is the Contribution Margin Income Statement?
Contribution margin income statements refer to the statement which shows the amount of contribution arrived after deducting all the expenses that are variable in nature from the total revenue amount and further fixed expenses are deducted from the contribution to get the net profit/loss of the business entity.
It is a special format of the income statement that segregates the variable and fixed expenses involved in running a business. It shows the revenue generated after deducting all variable and fixed expenses separately. In simple words, this format expresses the revenue generated after paying all the variable costs.
- The Contribution MarginContribution MarginThe contribution margin is a metric that shows how much a company's net sales contribute to fixed expenses and net profit after covering the variable expenses. As a result, we deduct the total variable expenses from the net sales when computing the contribution.read more Income Statement format has fixed expenses as a part of overhead costs instead of production costs. To explain it in a better way, fixed expenses incur even if the sales volumes go up or down. Hence they are independent of what the sales are. However, the variable expenses tend to shoot as the production increases.
- All we need to do is deduct the variable expenses from revenue, which would give contribution margin as a result. From the contribution margin, when we deduct all fixed expenses, it concludes to Net Profit or Net LossNet Profit Or Net LossNet loss or net operating loss refers to the excess of the expenses incurred over the income generated in a given accounting period. It is evaluated as the difference between revenues and expenses and recorded as a liability in the balance sheet.read more.
- It cannot be used for Generally Accepted Accounting PrinciplesGenerally Accepted Accounting PrinciplesGenerally accepted accounting principles (GAAP) are the minimum standards and uniform guidelines for the accounting and reporting. These standards prohibit firms from engaging in unethical business activities and enable for a more accurate comparison of financial reports to investors.read more (GAAP) statements and is used by managers internally. This format is handy in decision making. It helps in understanding the cost behavior by separating the fixed and variable expenses.
Contribution Margin Income Statement Format:
Every dollar of revenue generated goes into either of Contribution Margin or Variable Costs. What’s left in contribution margin goes in covering Fixed CostsFixed CostsFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.read more and remaining into the Net Profit / Loss.
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For eg:
Source: Contribution Margin Income Statement (wallstreetmojo.com)
Unlike a traditional income statement, the expenses are bifurcated based on how the cost behaves. Variable cost includes direct materialDirect MaterialDirect materials are raw materials that are directly used in the manufacturing process of a company's goods and/or services and are an essential component of the finished goods manufactured.read more, direct labor, variable overheads, and fixed overheads. It does not matter if your expenses are production expenses or selling and administrative expenses. If they are variable, they must be included in variable costs. The same thing goes with fixed expenses; if they are fixed, they must be included in fixed costs.
The contribution margin and the variable cost can be expressed in percentage of the Revenue. These are called the contribution margin ratio and variable cost ratio, respectively.
Examples of Contribution Margin Income Statement
Example #1
‘My Cake Shop’ is a cake and pastry business that you run. With the rising demand in customers asking for workshops for baking their cakes, you started weekend workshops for the same. The revenue generated for the month was $7,500, which included direct sales of $6,000, and income from conducting Weekend Cake Workshops was $1,500. Wages paid were $2,000, and the expense incurred in procuring materials summed up to a total of $1,500. Rent of $1,000 was paid, and the insurance premium payment of $200 was also made. The contribution margin income statement would look like this:
Example #2
Last month, Vienna Inc. sold its product for $2,000 per unit. The fixed production costs were $3,000, and fixed selling and administrative costs were $50,000. Variable production costs were $1,000 per unit, and variable selling and administrative costs were $500 per unit. Vienna Inc. sold 500 units for the previous month.
Prepare a contribution margin income statement.
Calculation:
- Sales = Selling price per unit x No. of units sold =$2,000 x 500 =$1,000,000
- Cost of Goods SoldCost Of Goods SoldThe cost of goods sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company.read more = $1,000 x No. of units sold =$1,000 x 500 =$500,000
- Selling and administrative costs = $500 x No. of units sold =$500 x 500 =$250,000
Contribution Margin Ratio
Contribution Margin Ratio = (250,000 / 1,000,000) x 100
Contribution Margin Ratio = 25%
Variable Cost Margin Ratio
Variable Cost Margin Ratio = (750,000 / 1,000,000) x 100
Variable Cost Margin Ratio = 75%
Contribution Margin Income Statement vs. Traditional Income Statement
- It replaces gross margin.
- Fixed expenses are cached lower after contribution margin.
- Variable expenses are a part of calculating the contribution margin.
Advantages
- Data is placed in an organized manner, which helps the management to understand how changes in production and sales volumes will affect the profit.
- It helps in identifying variable expenses that are eating up too much of the revenue.
- Even though the numbers remain the same, it gives a different perspective of the current financial condition.
- Better analysis can be done as the fixed and variable expenses are bifurcated.
- It can be used for break-even analysisBreak-even AnalysisBreak-even analysis refers to the identifying of the point where the revenue of the company starts exceeding its total cost i.e., the point when the project or company under consideration will start generating the profits by the way of studying the relationship between the revenue of the company, its fixed cost, and the variable cost.read more.
Disadvantages / Limitations
- The format is not recognized by GAAP and hence cannot be shared with the external consumers of the financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more.
- It focuses only on the expenses side.
- The income statement is accessible only to the internal audience.
Important Points
- It depicts expenses based on its functional area.
- It distinguishes between fixed and variable expenses.
- The statement helps in decision making for the management.
- With the help of the statement, we can conduct a break-even analysis.
Conclusion
The contribution margin income statement is a special format of the income statement that focuses on expenses that are bifurcated for better understanding. Looking at this statement, it can be easily understood as to which business activity is resulting in a revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more leak.
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