Contribution: The Real Income

There is a huge danger in business…of focusing on growing the top line of sales or revenue in ways that don’t increase profit.

It’s sometimes called the busy fools syndrome!

You do more and make less money.

You need to move your attention from the top line sales number to your real income – your contribution.

What is Contribution?

In total Contribution equals Sales minus Variable Costs

And at the unit level, contribution per unit equals the sales price per unit minus the variable cost per unit.

If you are not sure about variable costs, go back to Sales and Costs.

This is the extra profit you will make from selling one more item.

Contribution is tightly defined but you may also think you know the measure as Margin, Gross Margin or Gross Profit.

Other Measures Like Contribution

You may be right but often those names don’t match our strict definition.

Gross Margin may be sales minus variable product costs but exclude carriage and commissions which also vary with the volume or value of sales.

Gross Profit often goes the other way.

I’ve seen plenty of accounts in the UK because it’s required by the Companies Act where gross profit includes some costs that are fixed.

There Are Grey Areas

There are also some grey areas.

In a factory the machines are powered by electricity and if they run longer to produce more output, electricity costs will increase… but there is also a level of usage for lights and perhaps heating which is more like a fixed cost.

This is typical of accounting and finance. There are few absolutes but it’s important to embrace the idea of being approximately right and not precisely wrong.

You have to make your own mind up but remember, it’s better to be approximately right than precisely wrong.

Return to P1M3 How Profit is Created

See Example of Sales Increase & Contribution Fall

Twitter Digg Delicious Stumbleupon Technorati Facebook Email

No comments yet... Be the first to leave a reply!

Leave a Reply