The contribution margin income statement is a useful tool when analyzing the results of a previous period. This statement tells you whether your efforts for the period have been profitable or not. The resulting value is sometimes referred to as operating income or net income.
This statement is not used for financial reporting, but uses the information generated by creating your financial statements to determine your net profit or loss for the period. Net profit is making more than you spent in the period, and net loss is spending more than you made.
Fixed and Variable Expenses
Before you begin your calculations, you'll need to understand fixed and variable expenses.
Variable costs (or expenses) are any costs that do not remain consistent. These could include energy, wages (for labor related to production) or any other cost that raise or lower with the output levels of your business.
Fixed costs are costs that may change over time, but they are not related to the output levels. These costs include equipment rent, building rent, storage space, or salaries (not related directly to production. If they are, you count them as variable costs).
A contribution margin income statement deducts variable expenses from sales and arrives at a contribution margin. Fixed expenses are then subtracted to arrive at the net profit or loss for the period.
Calculating Your Contribution Margin
The first step in creating your contribution margin income statement is to calculate the contribution margin. To do this, you'll need your sales revenue and variable cost information. The variable costs will include relevant variable administrative costs and any variable cost related to production. The formula for your contribution margin is:
Net Product Revenue (Sales) - Total Variable Costs ÷ Product Revenue
For example, if your product revenue was $500,000 and total variable expenses were $250,000, your contribution margin would be $250,000 ÷ $500,000, or 50%.
Calculating Your Contribution Margin Income
To calculate your contribution margin income, you'll need to have your total fixed production expenses (production expenses, fixed administrative expenses, and sales expenses) and subtract that value from the contribution margin. The formula is:
Contribution Margin - Total Fixed Production Expenses = Net Profit or Loss
If your total fixed production expenses were $300,000, you'd end up with ($50,000) in net profit ($250,000-$300,000). This is a loss, so you'd have to figure out how to compensate for the -$50,000 by increasing sales or decreasing fixed costs.
You'd need to decrease costs by $50,000 to break even. To calculate how much to increase sales divide the loss by the contribution margin.
$50,000 ÷ 50% = $100,000
You'd need $100,000 more in sales to break even.
A simple contribution margin income statement looks similar to this:
|Contribution Margin Income Statement|
|-||Variable Expenses (Administrative, Selling, and Production)||$250,000|
|-||Fixed Expenses (Production, Overhead, Selling)||$250,000|
|=||Net Profit or Loss||$(50,000)|
Break-Even Point in Dollars or Units
Your break-even point is the point in which your sales equal your costs. The break-even point can be calculated in units or sales dollars. If you calculate in units, your formula would look like this:
Fixed Costs ÷ (Revenue per Unit - Variable Cost per Unit) = Break-Even Point (Units)
For the break-even point in sales dollars:
Fixed Costs ÷ Contribution Margin = Break-Even Point
In a different example than the previous one, if you sold 650 units in a period, resulting in $650,000 net profit, your revenue per unit is $1,000. If variable expenses were $250,000, so you'd have $385 in variable expenses per unit (variable expenses÷units sold).
Fixed Costs per unit ÷ (Revenue per Unit-Cost per Unit) = Break-Even in Units
Revenue cost per unit-cost per unit ($1,000 - $385) = $615
Fixed costs $300,000 ÷ $615 = 487
You would have needed 487 units to break even for this period. More than 488 units results in a profit, and 486 units or less result in a loss.
When you calculate your contribution margin and break-even point, be sure to use units or value consistently unless you are comfortable converting them back and forth. Depending on who is viewing your information, you may need to decide if you want to use both methods.
Parties concerned with the financial aspects of the business may be more likely to understand break-even in dollars; someone interested in operations may be more concerned with break-even in units.