What is Cost-Volume-Profit (CVP)?

Cost Volume Profit (CVP) measures the relationship that a change in production volume affects cost and overall profitability.

This area of analysis is performed by management accountants and is used to make decisions around product mixes, risk analysis and decision making.

What is Contribution Margin?

Contribution margin is the amount of each product sold that goes towards fixed costs. In other words, it is like the gross profit, the amount of money you make after deducting all variable costs.

Hence the formula for contribution margin is: Contribution Margin Per Unit = Selling Price Per Unit - Variable Cost Per Unit OR Contribution Margin (Dollars) = Sales - Variable Cost

Worked Example: Simple Contribution Margin Calculation

Balance New is a company that produces running shoes that sell for $100. The company produced 2,500 shoes in the year.

The company incurs the following costs:

Direct Materials of $25

Direct Labour of $30/hr, with each shoe taking 30 minutes of direct labour to produce

Factory Overhead of $5 per shoe

Fixed Overheads of $100,000 per year

What is the contribution margin per unit and contribution margin in dollars for the year?

Solution:

Step 1: Calculate the Cost Per Unit

Direct Materials: $25 per shoe Direct Labour: $30/hr at 30 minutes per shoe. Therefore, the cost is $30 * 0.5 = $15 direct labour per shoe.

Factory Overhead: $5 per shoe Total Variable Cost Per Unit = $25 direct materials + $15 direct labour + $5 factory overhead = $45 per shoe

Step 2: Calculate the Contribution Margin Per Unit

Contribution Margin Per Unit = Selling Price Per Unit - Variable Cost Per Unit Hence: Contribution Margin Per Unit = $100 - $45 = $55 per shoe

Step 3: Calculate the Contribution Margin Per Year

Contribution Margin Per Year = Contribution Per Unit * Units Produced Per Year Contribution Margin Per Year = $55 * 2,500 = $137,500

Therefore: Contribution Margin Per Unit = $55 per shoe

Contribution Margin Per Year = $137,500