Effect of Change in Variable Cost and Sales Volume on Contribution Margin and Profitability:
What is the effect of change in variable cost and sales volume on contribution margin and profitability.
The following data is used to show the effects of changes in variable cost and sales volume on the company’s contribution margin and profitability.
Variable Expenses—$150 (60% of sales)
Contribution Margin—$250 – $150 = $100 (40% of sales)
Fixed Expenses: $35,000 per month
Suppose that a company is currently selling 400 units per month. Management is considering the use of higher-quality components, which would increase variable costs (and there by reduce the contribution margin) by $10 per unit. However the sales manager predicts that the higher overall quality would increase sales to 480 units per month. Should the higher quality components be used?
The $10 increase in variable costs will decrease the unit contribution margin by $10-from $100 down to $90.
| Expected total contribution margin with higher-quality components:
|480 units × $90 per unit
| Present total contribution margin:
|400 units × $100 per unit
|Increase in total contribution margin
According to this analysis, the higher-quality components should be used. Since fixed costs will not change, the $3,200 increase in contribution margin shown above should result in a $3,200 increase in net operating income.
You may also be interested in other articles from “cost volume profit relationship” chapter
- Contribution Margin and Basics of CVP Analysis
- Difference Between Gross Margin and Contribution Margin
- Cost Volume Profit (CVP) Relationship in Graphic Form
- Contribution Margin Ratio (CM Ratio)
- Importance of Contribution Margin
- Change in fixed cost and sales volume
- Change in variable cost and sales volume
- Change in fixed cost, sales price and sales volume
- Change in variable cost, fixed cost, and sales volume
- Change in regular sales price
- Break even point analysis (calculation of break-even point by contribution margin and equation method)
- Target profit analysis
- Margin of safety
- Sales Mix and Break Even with Multiple Products
- Cost Volume Profit (CVP) Consideration in Choosing a Cost Structure
- Operating Leverage and degree of operating leverage
- Assumptions of Cost Volume Profit (CVP) Analysis
- Limitations of Cost Volume Profit Analysis