Illustrate about Contribution Margin (CM) Ratio with example

 A relationship between the cost, volume and profit is the contribution margin. The contribution margin is the revenue excess from sales over variable costs. The following chart shows the income statement of a company X, which has been prepared to show its contribution margin:

Sales	$1,000,000
(-) Variable Costs	$600,000
Contribution Margin	$400,000
(-) Fixed Costs	$300,000

 

Income from Operations $100,000

Uses: The concept of contribution margin is particularly useful in the planning of business because it gives an insight into the potential profits that can generate a business.

 

Contribution MarZin (CM) Ratio: The margin contribution can also be expressed as a percentage. The contribution margin ratio, which is sometimes called the profit-volume ratio, indicates the percentage of each sales dollar available to cover fixed costs and to provide operating revenue. For the company Fusion, Inc. the contribution margin ratio is 40%, which is computed as follows:

 Contribution Margin Ratio = (Sales - Variable Costs)/Sales

 The contribution margin ratio measures the effect on operating income of an increase or a decrease in sales volume. For example, assume that the management of Fusion, Inc. is studying the effect of adding $80,000 in sales orders. Multiplying the contribution margin ratio (40%) by the change in sales volume ($80,000) indicates that operating income ~\ ill increase $32,000 if additional orders are obtained. To validate this analysis the table below shows the income statement of the company including additional orders:

Sales	$1,080,000
(-) Variable Costs	$648,000	(1,080,000 x 60%)
Contribution Margin	$432,000	(1,080,000 x 40%)
(-) Fixed Costs	$300,000

 Income from Operations $132,000

Variable costs as a percentage of sales are equal to 100% minus the contribution margin ratio. Thus, in the above income statement, the variable costs are 60% (100% - 40%) of sales, or $648,000 ($1'080,000 X 60%). The total contribution margin $432,000, can also be computed directly by multiplying the sales by the contribution margin ratio ($ I'080,000 X 40%).