Contribution Margin and Break Even Analysis

Topics: Variable cost, Contribution margin, Management accounting Pages: 5 (1622 words) Published: March 26, 2011
Contribution Margin and Break Even Analysis.
Many factors come into play in determining business success. One of them is the financial factor. For a company to set financial goals it is crucial that its management know in detail the products or services they sale or provide. This is the analysis of two different scenarios at Aunt Connie's Cookies Simulation (University of Phoenix, 2011) and the financial performance of Jamestown Electric Supply Company (Heiter, et. al. 2008). During both analysis I applied concepts like fixed and variable costs, contribution margin, break-even point, indifference point, and operating leverage. Aunt Connie's Cookies Scenario Simulation

The Aunt Connie's brand grew successfully producing Lemon Crème and Mint cookies. Maria Villanueva is the current chief executive officer of this family-owned company (University of Phoenix, 2011). She faces critical decisions to make because both the lemon crème and mint cookies prices increased and sales volume decreased. Maria should apply several accounting concepts to reach her goal of increasing sales and revenue for the company. Some opportunities and challenges lined up for Aunt Connie's Cookies like large bulk orders and the buyout of a competitor's factory (University of Phoenix, 2011). A confectioner commissioned Aunt Connie's Cookies to fill a bulk order of one million packages of the Real Mint cookies delivered in one month's time. The stipulations of the order weights greatly on the company as the confectioner will only pay $1.20 per package, which is much cheaper than the mass market selling at $1.50 per packet. Rejecting the order may seem foolish as Aunt Connie's Cookies has the capacity to produce the order, and could be missing out on a good opportunity if she declines to fill the order (University of Phoenix, 2011).

In deciding which cookie's production to reduce, Maria took into account the concepts of contribution margin, unit contribution margin, and operating profits. This decision was necessary to create sufficient capacity to accommodate the mint cookies bulk order. The contribution margin is the amount of money that remians from the revenue obtained after sales to pay for fixed expenses and to contribute to the operating profits after deducting variable expenses. Alternatively, the unit contribution margin of each unit sales, in this case each pack of cookies adds to profit. Finally, operating profit is the profit earned from a company's core business operations, also known as earnings before interest and tax (EBIT).

Maria calculated the contribution margin and the unit contribution margin for each type of cookie, determined to reduce the production of lemon crème cookies and to increase the production capacity for the bulk order of real mint cookies. Maria can sell mint cookies at $1.20 per package, below the selling price of $1.50 because the real mint cookies provide a greater total contribution margin and that the lemon cream cookies provides a greater unit contribution margin. Maria knew that Aunt Connie's Cookies should produce more of the cookies with the greater contribution margin per unit to maximize the shop's operating profit. If the scenario changed, and the bulk order was for lemon cookies, Maria would have to turn over the order to the confectioner. The unit contribution margin for the lemon cookies is smaller and Maria would have to increase the production capacity to make the same operating profit as for the mint cookies, to the point of going beyond the factory's production capacity.

Maria faced the opportunity to buy a peanut butter cookie plant. She could use this plant to make more lemon crème cookies because the near-term demand exceeded 600,000 packs. The challenge for Maria is to make a decision about going forward or not with this business (University of Phoenix, 2011). If the new plant has a break-even volume of crème cookies of 650,000...

References: Heiter, L.E. and Heitger, D.L. (2008, May). Jamestown Electric Supply Company: Assessing
Customer Profitabililty. Issues in Accounting Education, 23(2), pp. 261-280.
University of Phoenix (2011). Simulation: Contribution margin and break-even analysis.
Retrieved on January 30, 2011 from:
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