​Today’s Learning Objectives

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• distinguish between contribution and contribution margin ratio

• interpret margins of safety

• finding level of output in order to reach profit​

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​What is contribution margin ratio

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The bottom part of the break-even formula (selling price per unit less variable cost per unit) is known as the contribution per unit.

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It is called ‘contribution’ because indicates how a particular product contributes to the overall profit of the company and shows the portion of sales that helps to cover the company's fixed costs. ​

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Any remaining revenue left after covering fixed costs is the profit generated. It is good to have a high contribution margin ratio, as the higher the ratio, company is available to cover all the expenses.

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​Formula for contribution margin ratio

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​​The contribution margin ratio is the contribution from an activity expressed as a percentage of the sales revenue.

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Contribution and sales revenue can both be expressed in per-unit or total terms.

​Margin of safety

​A margin of safety (MoS) is a difference between actual sales and level of breakeven sales. MOS is everytime we have excess of sales over break even.

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​Managers can utilize the margin of safety to know how much sales can decrease before the company or a project becomes unprofitable.

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This amount tells us how much sales can drop before we show a loss. A higher margin of safety is good.

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​Example of Margin of safety

​If, Minnesota Kayak Company needs to sell 28 kayaks at $500 each to break even. So in this example, $14,000 in sales is their break even point.

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Let’s assume their current sales of kayaks is 50 kayaks per month at $500 each, so $25,000. Using the formulas above, what is their margin of safety?

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$25,000−$14,000=$11,000$ is their margin of safety.

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What is their margin of safety percentage?

$11,000/$25,000=44% is their margin of safety percentage.

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Company can sell 44% fewer dollars worth of kayaks and still break even.

​Finding level of output to reach profit

To find preferable profit for the company, use the formula for break even point and add profit to the fixed costs

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BEP= fixed cost + profit / contribution

= fixed cost + profit / selling price -variable cost per unit​

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