Contribution Margin and Breakeven Analysis

Topics: Variable cost, Costs, Management accounting Pages: 2 (655 words) Published: January 19, 2006
Contribution Margin and Breakeven Analysis
Contribution margin is defined as total revenue from a product or service less the total variable cost. When the confectioner from Charlotte approaches Aunt Connie's with a bulk order for a million packs of real mint cookies, Maria should use cost-volume-profit analysis to decide which cookie's production to reduce in order to free up enough capacity to accept the bulk order. Cost-volume-profit analysis provides useful information concerning sales that are necessary to in order to break even or to earn a target profit. This analysis illustrates how profit is affected when the costs, volume, or prices of products or services are changed. Maria should calculate either lemon crème cookies or real mint has a greater contribution margin per unit. Contribution margin per unit is defined as contribution per unit divided by price per unit. Since lemon crème cookies production has a higher contribution margin per unit, Maria should accept the bulk order by reducing the current production volume for real mint cookies. Overall, when Maria seeks to maximize operating profits, it is better to produce more of the lemon crème cookies since it has a greater contribution margin per unit. On the other hand, when Maria was considering a large bulk order from the confectioner, she wanted to grab the order because total contribution margins as well as the operating profits from lemon crème cookies are less than that for real mint cookies. She suggested reducing the production volume for lemon crème cookies and producing more real mint cookies to accommodate the large bulk order. Maria should not accept the bulk order under these circumstances because it would not result in profit maximization. When Maria was considering buying the peanut butter cookie plant, one of her options was to convert it to make more lemon crème cookies. If the breakeven volume of lemon crème cookies in this new plant were 650,000 packs and continuing...
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