Contribution Analysis

What is Contribution Analysis?

Contribution analysis is used in estimating how direct and variable costs of a product affect the net income of a company. The study addresses the issue of identifying simple or overhead costs related to several production projects. Contribution analysis aids a company in evaluating how individual business lines or products are performing, by comparing their contribution margin dollars and percentage. Direct and variable costs incurred during the manufacturing process are subtracted from revenue to arrive at contribution margin. This is, therefore, a very crucial procedure in the growth of a business.

To learn more, check out our financial analysis fundamentals course.

Contribution margin formula

The formula for contribution margin dollars per unit is:

(Total revenue – variable costs) /  # of units sold

For example, a company sells 10,000 shoes for total revenue of $500,000 with the cost of good sold of $250,000, and shipping & labor expense of $200,000.

The contribution margin per shoe is ($500,000 – $250,000 – $200,000) / 10,000

Contribution = $5.00 per shoe

Download the Free Template

Enter your name and email in the form below and download the free template now!

To learn more, check out our financial analysis fundamentals course.

The Pros of contribution analysis

Contribution analysis helps in the assessment of how individual products are profitable to the company.

The significance of contribution analysis is that it gives certainty to the profitability of each product and makes you understand why the results are so. Contribution analysis clearly provides the specific external and internal factors that have an influence on a company’s income.

The Cons of contribution analysis

Some problems might come up when using this approach, regarding any of the following:

• Real life evaluations
• Confirmation of the  theories involved
• Relating the observation made by reducing uncertainty

Steps Involved

There are six steps that must be followed in the analysis, as outlined below:

1. Identify the problem to be assessed –  This means pointing out the target that you want to see the cost/profit analysis on.
2. Come up with a change theory and model – This means that you should come up with relevant policies with respect to the problem identified. This will help in understanding how the policies formulated going to help in influencing change.
3. Gather enough data on the model – It is important to get the existing evidence on the model formulated to ensure that it will be effective.
4. Assess  the performance based on the data collected and evidence – One way of getting the required evidence is through stakeholders and  witnesses
5. Dig up additional evidence – This is the stage where new data and evidence is added to the already existing information so that nothing is missed.
6. Revising the performance data and records – This process will help in the rectification of the weaknesses and improvement of the strengths.

To learn more, see the resources listed below and check out our financial analysis fundamentals course.

More Reading

• What is a Stock?StockWhat is a stock? An individual who owns stock in a company is called a shareholder and is eligible to claim part of the company’s residual assets and earnings (should the company ever be dissolved). The terms "stock", "shares", and "equity" are used interchangeably.
• Investment BankingInvestment Banking in IndiaLearn about investment banking in India. We list the top investment banks in India and outline how to get a job as analyst or associate. The history of investment banking in India traces back to when European merchant banks first established trading houses in the region in the 19th century.
• Debt ScheduleDebt ScheduleA debt schedule lays out all of the debt a business has in a schedule based on its maturity and interest rate. In financial modeling, interest expense flows into the income statement, closing debt balance flows onto the balance sheet, principal repayments flow through the cash flow statement, completing the scheudle
• Quid Pro QuoQuid Pro QuoThe term quid pro quo refers to an exchange of goods or services between two parties when something is assumed or expected to be given in return for something of equal value. It is often viewed as either a courtesy or a tacit agreement that "A" will do something for "B" because B has done something for A.
• Exchange Traded FundsExchange Traded Fund (ETF)An Exchange Traded Fund (ETF) is a popular investment vehicle where portfolios can be more flexible and diversified across a broad range of all the available asset classes. Learn about various types of ETFs by reading this guide.