Looking at this contribution margin example, we'll develop a contribution margin income statement to demonstrate the effect of the contribution margin and break-even point on the income statement:
Here is the example:
Break-even point in units = Fixed Expenses/Price - Variable Expenses
Break-even point = $60,000/$2.00 - .80 = 50,000 units
In order to develop the contribution margin income statement, we have to convert breakeven in units to breakeven in dollars. We use the contribution margin ratio to do this. Using the same example, variable expenses of $0.80 are 40% of sales of $2.00 per unit ($0.80/$2.00). To calculate breakeven in dollars, divide its fixed expenses by the contribution margin ratio of 60% ($60,000/.6 = $100,000). This means that the company has to make $100,000 in sales to breakeven.
If you want to check your work, calculate the company's variable costs using this method. Variable expenses are 40% of sales ($100,000 X .4 = $40,000). Sales of $100,000 minus variable expenses of $40,000 equal fixed costs of $60,000. You now know your calculations are correct because $60,000 are the stated fixed expenses of the company.
The table below shows you the firm's income statement in contribution margin format. It shows you that if one more unit of the product is sold, to total 50,001 units, then the Net Operating Profit will rise above zero and the firm will make a profit. However, if one unit less than 50,000 is sold, the firm will incur a loss.
Contribution Margin Income Statement for the Month of May, 2011
|Less: Variable Expenses||40,000||0.80|
|Less: Fixed Expenses||$60,000|
|Net Operating Profit||$0|