Accounting Business Reporting for Decision Making

CHAPTER 10 Cost–volume–profit analysis 431

10.3 Contribution margin ratio

LEARNING OBJECTIVE 10.3 Apply the contribution margin ratio to CVP calculations.

In some circumstances, there may be insufficient data to calculate the number of units of a product

required to reach the break-even point, or it may not be feasible to calculate the number of units. In these

circumstances, executing CVP analysis by using the contribution margin per unit is of little use. What

we can use instead is the contribution margin ratio. The contribution margin ratio is the percentage

by which revenue exceeds variable costs (or, alternatively, the contribution margin expressed as a per-

centage of revenue). It is particularly useful when seeking the total sales dollars required to break even

or earn a desired profit, rather than a specific number of units.

The contribution margin ratio can be calculated as:

Contribution margin per unit

× 100 = x%

Selling price per unit

or

Total contribution margin

× 100 = x%

Total sales

The contribution margin provides a measure of the contribution of every dollar of sales or fees to

cover fixed costs and generate profit. This is demonstrated in illustrative example 10.3.

ILLUSTRATIVE EXAMPLE 10.3

Contribution margin ratio

Referring back to the data for Advantage Tennis Coaching (ATC) in illustrative example 10.1, the con-

tribution margin ratio would be calculated as:

($150 – $90)

= 0.40 or 40%

$150

Break-even sales can then be calculated as total fixed costs/contribution margin ratio. In ATC’s case

this is:

$1800

= $4500 in sales (total parents’ contributions)

0.40

We can confirm this result, as the break-even units (players) in illustrative example 10.1 were 30. At a

selling price (or parent contribution) of $150, this gives total sales of $4 500 (30 units or players × $150).

The contribution margin ratio can be particularly useful when individual unit price and cost data are

not available, or when the focus is on calculating the sales dollars required to break even. It can also be

used to analyse the impact of a change in sales revenue on profit. Consider the following independent

data.

Product A Product B Total

Sales revenue

Variable costs

$ 20 000 000

8 000 000

$ 10 000 000

5 000 000

$ 30 000 000

13 000 000

Contribution margin $ 12 000 000 $ 5 000 000 $ 17 000 000

Contribution margin ratio

Fixed costs

0.60# 0.50+

$

0.567

9 000 000

*

# 0.60 = $12 000 000/$20 000 000

+ 0.50 = $5 000 000/$10 000 000

* 0.567 = (($20 000 000/$30 000 000) × 0.6) + (($10 000 000/$30 000 000) × 0.5)