Contribution Analysis – What is It?

Running a business requires steady navigation through an ever changing market. No matter what type of business you are running, you need to keep up with all the latest market trends and do a regular contribution analysis. You need to also keep up with all the latest price changes and costs. Are you charging too much or too less? What are your most profitable products? What parts of my business are more liabilities than assets? Should I cut any costs?

Understanding the costs of a business

You need to understand how the money is contributed throughout your business. This can take careful analysis. You need to understand fixed, variable, and semi-variable costs. Fixed costs are what your business must pay, no matter what the sales volume. These can include: insurance, rent, utilities, etc.
Of what you really need to be aware of in a contribution analysis are the variable costs. These are directly affected by the sales volume, and can include sales commissions, cost of items, travel expenses, and so forth. The semi-variable costs are those that increase with sales volume, but not as directly or as significantly as those with variable costs.

Contribution margin

You need to determine the contribution margin for your company. This represents the dollar amount that is left after each sale, after all the variable costs have been paid. It is the portion of the sales dollar that you can use toward fixed costs. You can use software to conduct a contribution analysis on your company to learn the margin.

Knowing the overall margin is beneficial because you can compare it to prior bookkeeping records, to determine if there is a trend, or if it is decreasing or increasing. You can determine additional contribution margins of particular products or product lines. This information will be good to know so that you can decide whether or not a particular product or expense is worth keeping.

You can determine your most profitable service or product by conducting a contribution analysis.Say, for example, that product #1 has sales of $50,000 over the past year. Product #2 has sales of $75,000 over the past year. You would think that product #2 is the more profitable of the two, but learning the contribution margin may prove otherwise. What if product #1 covers .57 cents of every sales dollar toward fixed costs while product #2 only covers .40 cents. Clearly, product #1 is the real contributor.

If any of this sounds confusing to you, you will be glad to know that there is contribution analysis software available. It will provide you with solutions to discovering which of your products are worth keeping. You can also determine the lifetime value of each client if your company provides services. How much is your company earning per customer or client, and how much of that money do you need for paying your employees and taking care of all the costs? Should you adjust your marketing or advertising expenses?

Knowing the answers to these questions will help you make better business decisions in the long run. Understanding how money is contributed is not very difficult, just as long as you understand this equation: sales – (market expenses + variable operating costs + cost of goods sold).