What is Contribution Margin Income Statement?
Definition: A contribution margin income statement deducts variable costs from revenues to arrive at the contribution that is available to pay for fixed costs. After fixed costs are deducted from the contribution margin, the remaining amount, if any, is the profit.
What does contribution Margin Income Statement mean?
The contribution margin income statement arrives at the profit that a company makes in a different manner from the traditional income statement.
Here’s how the contribution margin income statement calculates net profit:
Revenues – Variable costs = Contribution Margin
Contribution Margin – Fixed Costs = Net Profit
How is this method different from the regular income statement? Companies usually calculate their net profit by deducting the “cost of goods sold” from revenues to arrive at gross profit. Subsequently, operating expenses are deducted to get the operating profit. Finally, all other expenses including taxes and interest are accounted for to arrive at the net profit.
Why should a company use the contribution margin income statement method instead of the traditional method? The contribution margin method allows a company to:
⇨ Decide whether to continue producing a certain product. It would normally be preferable to produce a good that provides a higher contribution margin.
⇨ Arrive at product pricing decisions in a more accurate manner.
⇨ Devise a sales commission structure that provides the greatest benefit to the company.
Remember that the key difference between a contribution margin income statement and the regular gross margin statement is that the former bunches variable costs together. The gross margin statement, on the other hand, adopts a different approach. It groups cost of goods sold under one head and does not differentiate between fixed and variable costs.
However, the net profit under both methods is the same.
Example of contribution Margin Income Statement
Yale Corporation, a manufacturer of gaskets for the auto industry, prepares its contribution margin income statement for May 2018:
A contribution margin income statement is different from a traditional income statement in one crucial respect. It calculates the contribution margin by deducting variable costs from sales. The regular income statement does not differentiate between variable costs and fixed costs.