CONTRIBUTIONMARGIN EQUALS PROFITABILITY … THE EASYWAY!
By: Eric Hankins
G rowing the top-line (revenue) of a business isn’t necessarily a difficult activity. However, ensuring as much revenue as possible makes it way down to the bottom-line in the form of ‘profit’ can seem daunting if not effectively managed. After all, a business can grow its way to bankruptcy if the only measurement that mattered to it was top-line revenue growth. So how does a business owner ensure they are effectively growing revenue while still effectively improving profitability? There are many ways to do this, but one of the most effective ways is to maintain a proper contribution margin. Contribution Margin is calculated very simply: 100 percent - Variable Cost percent = Contribution Margin. This is the same way that a business’ Gross Profit Margin is calculated, but Contribution Margin is viewed a little differently. Simply put, Contribution Margin is ‘what’s left over’. By ‘what’s left over’; we mean after the revenue is calculated and the variable costs to produce that revenue are deducted, it’s ‘what’s left over’ to pay for all fixed costs (which includes owner salaries) and business profits.
How it works: The better your business’ Contribution Margin, the less additional revenue it takes to cover the additional profit, fixed costs, or owner salary. With this in mind, determining the needed additional revenue to cover the increased profit/fixed cost/ salary is simple: Take the planned increase in profit, fixed cost, or salary…and divide it by your Contribution Margin. (Planned Cost Increase ÷ Contribution Margin Percent = Additional Revenue Needed)
See the following tables for examples:
CONTRIBUTION MARGIN: 55%
Planned Cost Increase
Additional Revenue Needed
Additional CSR
$25,000
$45,454.55
Additional Profit
$50,000
$90,909.09
$20,000
$36,363.64
Additional Salary
• If you are looking at your P&L and wondering how to improve your profitability…the first place you should look is your Contribution Margin. • If you want to add another Customer Service Representative (CSR) to your office staff and wondering how much revenue needs to be generated to break even…the first place you should look is your Contribution Margin. • If you want to add to your owner’s salary and wondering how much revenue needs to be generated to break even…the first place you should look is your Contribution Margin.
CONTRIBUTION MARGIN: 45%
Planned Cost Increase
Additional Revenue Needed
Additional CSR
$25,000
$55,555.56
Additional Profit
$50,000
$111,111.11
$20,000
$44,444.44
Additional Salary
Another way to look at this is to consider that very small changes in Contribution Margin can have a very large impact on your business’ overall profitability. Consider the following scenario. In this scenario, there are four shops in the same town with the first shop being the one that the other three are measured against.
22 PIPELINE® | EDITION 2 2017
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