Importance of Contribution Margin - Advantages of Cost Volume Profit (CVP) Analysis:

Learning Objectives:

1. What is the importance of contribution margin?
2. What are the advantages of cost volume profit (CVP) analysis?

Cost volume profit analysis (CVP analysis) can be used to help find the most profitable combination of variable costs, fixed costs, selling price, and sales volume. Profits can sometimes be improved by reducing the contribution margin if fixed costs can be reduced by a greater amount. More commonly, however, we have seen that the way to improve profits is to increase the total contribution margin figure, Sometimes this can be done by reducing the fixed costs (such as advertising) and thereby increasing volume; and some times it can be done by trading off variable and fixed costs with appropriate changes in volume. Many other combinations of factors are possible.

The size of the unit contribution margin (and the size of the contribution margin ratio - CM ratio) is very important. For example, the greater the unit contribution margin, the greater is the amount that a company will be willing to spend to increase unit sales. This explains in part why companies with high unit contribution margin (such as auto manufacturers) advertise so heavily, while companies with low unit contribution margin (such as dishware manufacturers) tend to spend much less for advertising. In short, the effect on the contribution margin holds the key to many decision.

You may also be interested in other relevant articles:

• 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 the contribution margin
• CVP consideration in choosing a cost structure
• Operating leverage--degree of operating leverage
• Assumptions of CVP analysis
• Break even point analysis
• Target profit analysis
• Margin of safety
• Sales mix and break even with multiple products
• Limitations of Cost Volume Profit Analysis

 

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