Contribution Margin Analysis

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					          Contribution Margin
                Analysis
                 July, 2011


PROMISE
PROMISE
PROMISE
PROMISE
Contribution Margin Analysis - WHY ?

   Key Financial Management Concept / Tool
   Higher Company Profitability
   Better Pricing Decisions
   Improved Strategic Thinking
   Foundation for Business / Financial Modeling
   Simpler !!
   Teachable !!


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Renaissance EXECUTIVE FORUMS
                Calculating Breakeven Volume

 Acme Manufacturing
  - Gross Profit: 25% of Revenues
  - Overhead (SG&A Expenses): $1 MM

 What is the Breakeven Revenue Level ?




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Renaissance EXECUTIVE FORUMS
                Calculating Breakeven Volume

 Acme Manufacturing
  - Variable Contribution Margin: 33% of Revenues
  - Fixed Overhead (SG&A Expenses): $ 1.2 MM

 What is the Breakeven Revenue Level ?




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Renaissance EXECUTIVE FORUMS
    Contribution Margin Analysis – WHAT ?

 Analyze FIXED vs VARIABLE Expenses


 Improve CAPACITY UTILIZATION

 Increase Total Company PROFITABILITY




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Renaissance EXECUTIVE FORUMS
      Contribution Margin Pricing – WHAT ?


 Increase Total Company PROFITABILITY
 Strategic Use of DISCOUNTED PRICING with Select
  Customers


“Any incremental revenue exceeding the Variable Cost of
delivering a product or service makes a contribution toward
covering total company Fixed Expenses.”



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Renaissance EXECUTIVE FORUMS
                 Contribution Margin Analysis

 What are some Fixed Expenses that might be in the
  Cost of Goods Sold section of your P&L ?

 What are some Variable Expenses that might be in
  the SG&A section of your P&L ?




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Renaissance EXECUTIVE FORUMS
                 Contribution Margin Analysis

 How can Capacity be defined ?
  - Plant or Warehouse Throughput
  - Owner’s Available Time
  - Customer Service: Maximum Incoming Calls
  - Salespeople: Maximum Face-to-Face Meetings
  - Rooms Available
 What is a realistic target for Capacity Utilization ?


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Renaissance EXECUTIVE FORUMS
  Contribution Margin Analysis – WHERE ?

 Seasonal Retail Sales Discounts

 Hotels.com

 Airlines

 Where else ?


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Renaissance EXECUTIVE FORUMS
      Comparison to Full / Absorption Accounting


 Full / Absorption Accounting allocates Fixed Overhead
  Expenses to Divisions, Products, Jobs, Locations, Sales
  People, Estimates, Quotes, etc…..usually on the basis of
  revenues.

 Based on Prior Period Results.
 Misleading Assessments of Unit Profitability
 Lost Business and Lower Total Company Profit

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Renaissance EXECUTIVE FORUMS
                 Classic Example - Contribution
                         Margin Pricing
 Angelo imports light bulbs - Needs Domestic Supplier
 Supreme manufactures light bulbs - Has Excess Capacity
                              Supreme Angelo
          Variable Raw Material    $ 0.05      N/A
          Variable Labor             0.10       N/A
          Allocated Fixed Overhead   0.08       N/A
          Total Cost               $ 0.23     $ 0.24
          Regular Selling Price      0.30       0.30
          Gross Profit               23%       20%
          Discount Price to Angelo   0.22       N/A
          Contribution Margin        32%       27%
   $ 15 MM 5 year Supply Agreement adds $4.8 MM to Supreme Profits

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Renaissance EXECUTIVE FORUMS
                       Capacity Utilization
Critical Requirement - Excess Capacity

Key Question - Can we add volume using Contribution Margin Pricing
               without needing to increase Fixed Expenses ?

Strategic Question for Supreme - Would pricing at $0.13 ever make sense ?
                               - How about $0.09 ?

Can Direct Labor ever be considered Fixed ?




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Renaissance EXECUTIVE FORUMS
     Contribution Margin Pricing (CMP)
                     Max


         Capacity
         Utilization




                  Min                              Max
                                          Use of
                                          CMP
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Renaissance EXECUTIVE FORUMS
     Contribution Margin Pricing (CMP)
                     Max




          Capacity
          Utilization

                  Min                              Max
                                          Use of
                                          CMP
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Renaissance EXECUTIVE FORUMS
     Contribution Margin Pricing (CMP)

        Fixed
       Expenses

                                  CMP




                                          Max
                                          Profit
                                          Revenues
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Renaissance EXECUTIVE FORUMS
 Contribution Margin Pricing - Example
Situation - Acme Manufacturing generated $1 MM in
  revenues last year, selling 500 units at $2000 each,
  resulting in a Gross Profit of 40%. However, Acme
  showed zero net profit as SG&A expenses were
  $400,000.

 Coyote Distributing is interested in buying 100 units at
  $1500 each, well below Acme’s regular selling price.

 Should Acme accept the purchase offer ?
The Next Level is Closer Than You Think
Renaissance EXECUTIVE FORUMS
             Contribution Margin Analysis
 What were your revenues in 2010 ?
 What were your fixed expenses in 2010 ?
 What were your variable expenses in 2010 ?
 What was your Contribution Margin % ?
 What was your Breakeven Revenue ?
 What is the Revenue Level Needed to Generate an Extra $100,000
  in Company Net Income ?
 What is your current Capacity Utilization ?
 What opportunities do you have to employ Contribution Margin
  Pricing ?


The Next Level is Closer Than You Think
Renaissance EXECUTIVE FORUMS
             Contribution Margin Analysis
Applications

   Selling to a New Customer
   Selling More to a Current Customer
   Selling to a Competitor
   Smoothing Seasonal Sales Variations
   Quoting & Estimating
   Increasing Capacity Utilization
   Short Term / Long Term Pricing
   Buying From a Current or New Supplier

The Next Level is Closer Than You Think
Renaissance EXECUTIVE FORUMS

				
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