The gross profit calculation is nearly identical to the contribution margin, with one primary difference: It includes both variable and fixed costs. So the gross margin accounts for the base production-specific cost of any product, as well as the costs that change based on the volume of goods sold or produced. While the contribution margin is useful for multiple-scenario analysis, gross profit is usually used for historical calculations or projections with a specific sales volume.
Let us make an in-depth study of the meaning, relation with profit and importance of contribution of a firm.
Meaning of Contribution:
The difference between sales value and marginal cost of those sales is known as contribution.
If selling price of a product is Rs. 10 and its variable cost is Rs. 5, there is a contribution of Rs. 5.
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This Rs. 5 is, of course, not profit, since the fixed costs remain unpaid. Thus, contribution will first go to meet fixed expenses and the balance represents the profits of the undertaking. Therefore, contribution may be said to be equal to fixed cost and profit (or loss).
Putting the above into a simple equation we have:
Contribution (C) = Sales – Marginal Cost
or, Contribution (C) = Fixed Cost + Profit
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or, Contribution (C) = Fixed Cost – Loss.
Relation between Contribution and Profit:
Contribution is defined as the difference between sales value and variable cost of sales. It contributes towards fixed costs and profits. It is also equal to fixed cost plus profit. Profit is arrived at after deducting fixed cost from the contribution.
Since fixed costs remain unchanged, therefore, profit can be increased or decreased by changing contribution. If contribution comes down by Rs. X, the profit earned will also come down to the same extent. Suppose the contribution of a firm is Rs. 10,000 and its fixed cost is Rs. 7,000, then its profit would be Rs. 3,000.
Let us assume further that the firm’s contribution comes down to Rs. 9,000. This reduced contribution thus accounts for a reduction in the profitability of the firm to the same extent. Therefore, contribution and profit are directly related.
Importance of Contribution:
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A few benefits that management can obtain from knowing contribution margin are:
(i) Determination of break-even point:
It helps in the determination of break-even volume of production.
(ii) Selection of a product-mix:
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The product-mix which gives maximum contribution margin is to be considered as best product-mix.
(iii) Problem of key factor:
A key factor is a factor which limits the volume of production. The selection of a product will be on the basis of contribution per unit of key factor.
(iv) Acceptance or rejection of any new order:
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The course of action which yields the greatest contribution will be the most profitable.
(v) Fixation of selling price:
It helps in determining the selling prices under different circumstances such as trade depression, export sales etc.
(vi) Profit-maximisation through evaluation of alternative investment plans:
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The investment plan which yields the highest marginal contribution from the products is to be selected.
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Explain the difference between profit and contribution in an objective function. Why is it important for the decision maker to know which of these the objective function coefficients represent?
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https://brainmass.com/business/finance/profit-and-contribution-102671Solution Preview
Difference between profit and contribution in an objective function: Profit is equal to total revenue minus total variable cost minus total fixed cost, which can be modified as total contribution less of total fixed cost. Contribution is equal to total revenue minus total variable cost, which can be modified as total contribution. Difference between profit and contribution in an objective function is inclusion (non-inclusion) of fixed cost.
Objective function:
Profit = Total revenue - total variable cost - total fixed cost
= Unit ...
Solution Summary
This solution explains the difference between profit and contribution in an objective function and why is it important for the decision maker to know which of these the objective function coefficients represent. This solution is 349 words.
What is the difference between contribution margin and profit?
What Is the Difference Between Contribution Margin and Profit Margin? Profit margin is the amount of revenue that remains after the direct production costs are subtracted. Contribution margin is a measure of the profitability of each individual product that a business sells.
What is the difference between contribution and gross profit?
Gross profit is your income or sales less cost of goods sold (COGS), which are all fixed costs (above the line on your income statement). Contribution margin analyzes sales less variable costs, such as commissions, supplies, and other back office expenses (costs listed below the line on the income statement).
What is contribution to profit?
Contribution is the amount of earnings remaining after all direct costs have been subtracted from revenue. This remainder is the amount available to pay for any fixed costs that a business incurs during a reporting period. Any excess of contribution over fixed costs equals the profit earned.
Is contribution a profit or a loss?
Contribution is defined as the difference between sales value and variable cost of sales. It contributes towards fixed costs and profits. It is also equal to fixed cost plus profit. Profit is arrived at after deducting fixed cost from the contribution.
