Contribution Margin and Breakeven Analysis - Term Paper Example

?The concept of contribution margin is particularly important when a firm is considering whether to produce one product or another. In this case, contribution margin refers to the difference between the sales from a product and the variable cost per unit, meaning the amount of profit from a product per unit sold (Seal, Garrison and Noreen 200). The contribution margin helps to determine whether a firm or company will achieve the profits sought after the fixed costs have been deducted. Therefore, the concept of break even is also determined by the concept of contribution margin. As already stated, the contribution margin is determined by two major factors; the sales price, and the variable cost per unit. Therefore, the simulation can be analyzed in terms of these two factors. Maria can decide on which cookie’s production to reduce or increase by considering the contribution margin per unit per cookie type. This means that the cookie with the highest contribution margin per unit should be considered since the fixed cost is assumed equal or constant in every period; therefore, the profits are expected to be higher. The concept of contribution margin will be used to consider the cookies with the lowest contribution per unit, and, therefore, the cookie’s production can be reduced. However, this concept should not be considered if the asking price per unit for the order would result in a contribution margin that would not cover the fixed costs incurred. Since the profits are attained after the fixed costs are deducted from the contribution margin, Maria should consider a state where the asking sales price creates a contribution margin higher than the fixed costs incurred in the production process. The concept of breakeven point is also important in determining the product to produce and the reasons for producing the product. Near-term demand for a product is an important part of the determination of the kind of product to produce. The fact that lemon creme cookies provided increased capacity for production and increased the demand means that Maria should have taken it into consideration. Before the decision of profitability is considered, Maria should consider the demand for the cookies in the near future, since this is what determines the amount of profits, and thus, the survival of the company. The decision to introduce a new type of production in the company is considered as if the company was a starting venture. This means that since the breakeven point for the new blend of cookies is 650,000 packs, Maria should consider the product as a new one. This means that the current production and the expected demand should be a factor in determining the type of cookies to produce. The case study indicates that the current breakeven point for the cookies is 563,000 packs, and increasing capacity would increase in a new breakeven pint of 650,000 packs. The fact the new breakeven point is 650,000 packs should not be factor while considering the cookies to produce, instead, Maria should consider the fact that the production of the butter cookies would result in a loss for the company, therefore, it is advisable that the company produce the new blend of cookies. The decision for Maria would be to stop producing the peanut butter cookies and instead produce the lemon creme cookies. The simulation considered contains many key learning points, but the most important points are the contribution margin, fixed costs, and variable costs. As already described, the contribution margin refers to the difference between the variable cost and selling price per unit of a product, and determines whether a company will be profitable in a fiscal period. The contribution margin is a key point because it involves both the variable costs and selling price of a product, therefore, these factors do not need to be considered separately. The contribution margin determines whether the variable costs per unit incurred in production are enough to justify the selling price, and if the variable costs per unit are too high, the selling price is adjusted accordingly. The second learning point is the issue of fixed costs, which refer to the costs that are incurred by a production firm regardless of the volume of production. The fixed costs incurred in production do not depend on the amount of products or units produced, instead, the fixed costs are constant. The fixed costs are considered a key point because the profits that a firm makes are determined after the fixed cost is deducted from the contribution margin. As already stated, the contribution considers the variable costs per unit and the selling costs per unit; therefore, to determine the profits, the fixed costs from all units are deducted from the contribution. Therefore, fixed costs determine whether a firm will breakeven or make a loss. The last key point is the breakeven point, which refers to the point in which a firm earns contributions that are enough to cover fixed costs. As already stated, the profits that a company makes is computed by deducting the fixed cost incurred from the contribution margin, therefore, for a new firm, the breakeven point is the point where the contribution is enough to cover fixed costs. The breakeven point is a key part of operations since it can determine whether a firm will remain in operation or close business. This means that, since attainment of breakeven is a determinant of operations, a firm will want to attain breakeven point earlier in operations. A company needs to analyze contributions according to every unit of product sold if the company is to determine profits. For this section of the analysis, we will analyze the operations of Apple Inc., a company that operates in the computer hardware industry. This analysis will focus on the sales of the company’s products and the contribution made by each product to total revenues. The analysis of the sales of the products will focus on two main areas, the iPod and the Mac, which are the two main products produced by the company. According to an analysis, the net sales per unit of the iPod decreased by 12% in 2009 and 2008, a factor that lead top a reduction in total revenues. Conversely, net sales for the Mac declined by 3% in the year 2009, even though sales per unit increased by 7%, a factor that was occasioned by the decline in selling prices (Apple Inc., 2010). The two factors discussed above indicate that the concept of selling price and net sales contribute to the revenues that a firm earns. This means that the contribution of each product in the portfolio is evenly considered since the sales of one product will affect the net revenues, regardless of the sales of any other product. A key operating decision that Apple Inc. can decide on is the increase in selling prices for the Mac to match the contribution made by the iPod. The key concept used in this case is the concept of contribution margin, which indicates that the contribution made by a product will affect the net revenues made by the firm. Increasing the selling price of the Mac will increase the contribution per unit if the production volume is not increased, since the variable cost increase if production is increased. The fixed costs per production period will also not change, meaning that the total profits will increase at the same rate as the increasing sales price. This analysis focuses on the three key learning points identified in this paper; the fixed costs, variable costs, and contribution margin. The outcomes of the increase in selling costs will be to raise total contribution, which will in turn increase net income. Works Cited Apple Inc. 2010 Financial Results and 10-K Report, 2010. Seal, Will, and Garrison, Ray, and Noreen, Eric. Management accounting, 2008. Boston. McGraw Hill Higher Education. Print. Read More