Cost determination is relevant and essential in determining and identifying the most rewarding outputs for a company. Although all products may be having a positive return, this observation may not be sufficient to determine whether to produce such products. In all productions, there is always a limitation of resources, as a consequence, managers should always focus on producing products that yield the highest level of returns. This report on XYZ Company shows the various amounts of the contribution margins that the business products’ make. In addition, it also shows how the cost of logistics, demand, as well as tastes and preference affect and influence a business’ sales and profitability.
The contribution margin of various sales items has an impact in determining the type of products that a company should prioritize in its manufacturing process. Generally, a business prioritizes products that have the highest contribution margin. Those with the least contribution margins are the last to be prioritized. Simply, a products contribution is calculated by subtracting the variable cost from fixed cost. Accordingly, contribution margin reflects the amount of income that a business makes from selling every additional unit of the product. Noteworthy, fixed costs is already a sunk cost, therefore, increasing production does not affect it, unless it surpasses the necessary threshold. For instance, if a business leases a warehouse, whether it uses this facility or not, it will still pay the full amount of the lease. However, it may be forced to hire a new facility if its products have occupied all the available space in the warehouse.
A Chart Showing the Relationship Between Variable Cost, Fixed Cost, and Total Cost
From this chart, it is clear that once the fixed cost has been incurred, the variable cost is the only one that leads to the increase in total cost. As a result, the contribution margin of every new product to the company is calculated by subtracting variable cost from the total cost.
The contribution margin was greatest in the sale of decorated products, which had a margin of 4.645 in London, Rome, Tokyo, and Beijing. Nonetheless, these margins fell to lesser amounts in other cities such as 2.025 in Midwest. This variance in price depending on region shows how different tastes, demand, and costs such as logistics affect the overall contribution of a product. It is important to remember that when products have high demand, their prices increase. In this manner, demand affects price, which affects the contribution margin.
The importance of identifying the contribution margin is not only to identify products that have the highest profitability levels but to also inform the company on the most profit-maximizing sales mix. Simply, a sales mix is the combination of goods and services that a company sells. Since organizations have a limit on the number of products that they can manufacture, it is appropriate for them to form the right combination of goods and services that earn the highest contribution. In XYZ Company, decorated product had a contribution of $4.645 when sold in London. Tong had a contribution margin of $4.555 when sold in London. Therefore, a sales mix focusing on these two products sale in London can result in a lot of profits. Since XYZ Company products had a lot of demand in various cities, and the company had excess production capacity, it sold all products that were demanded in order to earn more income.
Understanding the breakeven point of a business is essential in determining the number of units that a business must sell in order to make a profit. A breakeven point is calculated simply by dividing the fixed costs of a business with its contribution. In light of this, it is worth noting that even if a product fails to earn the business a profit, as long as it has a positive contribution, and the business has excess production capacity, the company should still produce this product. Since XYZ has positive contribution margin on its products in all regions that it sells them, it should continue producing these goods because they are enabling it to quickly and easily breakeven. In addition, the company has the excess production capacity to even continue production of commodities that have the least contribution margins.
A Breakeven Chart
From this chart, it is clear that a business should produce all commodities that have a positive contribution margin. However, greater emphasis should be placed on those with the highest contribution margins in order to enable the business to quickly breakeven. Therefore, if XYZ Company focuses on increasing the sales of its decorated goods, it will make more profits and breakeven much faster.