The term contribution refers to the excess of selling price over variable cost of a product. Thus, it is a difference between sale price and variable cost.
Contribution (C) = Sales – Variable Cost or Fixed Cost + Profit
When sale is $80,000 variable cost 40,000, fixed cost $30,000. Calculate contribution.
Contribution = Sales – Variable Cost
= $80,000 – $40,000
Usefulness of contribution.
The contribution is useful to the management in the following ways.
(1) Useful in determining BEP. BEP is a point where sales values and total costs are equal. Excess output over BEP output will result in the Project.
(2) Helpful in knowing the desired profit. The profit will be when contribution exceeds its fixed costs. The amount of project which a company wants to earn depends upon its cost of capital. The BEP is no profit no loss area, the desired profit will show addition in output.
Profit= contribution – Fixed costs.
(3) Selection of best alternate. The concept of contribution helps in evaluating alternative proposals, viz to produce or not to produce to change the sales mix to explore foreign market etc.
Break-Even Point (BEP)
It is that point where cost incurred and revenues derived are always equal. It is also known as Zero Point costs. Excess output and sales over BEP is an indicator of profit.
BEP sales = Fixed expenses + variable costs
BEP in untis: Fixed expenses $80,000 sale price per unit $20, variable cost $15. Thus BEP (Units)
BEP= Fixed expenses / C
= 80,000 / 5
= 16,000 units.
|Sales value of 16,000 units x 20||$3,20,000|
|Variable cost – 16,000 x 15||2,40,000|
BEP (Sales) = BEP units x Per unit Sale
= 16,000 x 20
Use of Break-Even Point (BEP)
The following are the main uses of Break-Even Point (BEP).
(i) Knowledge of profitability. The BEP is useful in knowing the profitability of a product.
(ii) Helpful in changing sales price. The BEP is useful in changing sales price and its effects on business.
(iii) Desired Profit. The BEP is useful in knowing the amount of desired profits
(iv) Useful to expansion. The BEP is helpful in knowing the expansion of the business.
(v) Useful in knowing profit or loss on different levels of output. BEP is very useful in knowing the amount of profit or loss. When sale is more than BEP sale, there are chances of profit. When sales are less than BEP sales, the chances of loss are ample.