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5.
Contribution Margin
The concept of break-even analysis deals with the contribution margin of a product. The
contribution margin is the excess between the selling price of the good and total variable
costs. For example, if a product sells for $100, total fixed costs are $25 per product and total
variable costs are $60 per product, the product has a contribution margin of the product is
$40 ($100 - $60). This $40 reflects the amount of revenue collected to cover fixed costs and
be retained as net profit. Fixed costs are not considered in calculating the contribution
margin.
Formulas for Break-Even Analysis
The calculation of break-even analysis may be performed using two formulas. First, the total
fixed costs are divided the unit contribution margin. In the example above, assume total
company fixed costs are $20,000. With a contribution margin of $40, the break-even point is
500 units ($20,000 divided by $40). Upon the sale of 500 units, all fixed costs will be paid for,
and the company will report a net profit or loss of $0.
Alternatively, the break-even point in sales dollars is calculated by dividing total fixed costs
by the contribution margin ratio. The contribution margin ratio is the contribution margin per
unit divided by the sale price. Using the example above, the contribution margin ratio is 40%
($40 contribution margin per unit divided by $100 sale price per unit). Therefore, the break-
even point in sales dollars is $50,000 ($20,000 total fixed costs divided by 40%). This figured
may be confirmed as the break-even in units (500) multiplied by the sale price ($100) equals
$50,000.