Costs may be either directly or indirectly
related to a particular cost object. A cost object
is a segment, product, or other item for which costs may be
accumulated. In the Dobson Books Company example, the contribution margin for selling $200,000 worth of books was $120,000. The following are the steps to calculate the contribution margin for your business. And to understand each of the steps, let’s consider the above-mentioned Dobson example. Variable Costs depend on the amount of production that your business generates.

Once sales estimates become somewhat reasonable, it then becomes just a matter of number crunching and optimizing the company’s profitability. In order to properly implement CVP analysis, we must first take a look at the contribution margin format of the income statement. Further, it is impossible for you to determine the number of units that you must sell to cover all your costs or generate profit.

How to Calculate the Contribution Margin Ratio

Thus, you need to make sure that the contribution margin covers your fixed cost and the target income you want to achieve. Non-operating items, such as interest and taxes, are below the operating income line. The net income from continuing operations is the operating contribution margin income statement format income minus non-operating items. The final section lists extraordinary items, such as flood damage, and the bottom line is the net income or loss for the period. Because a business has both variable and fixed expenses, the break-even point cannot be zero.

In this chapter, we begin examining the relationship among sales volume, fixed costs, variable costs, and profit in decision-making. We will discuss how to use the concepts of fixed and variable costs and their relationship to profit to determine the sales needed to break even or to reach a desired profit. You will also learn how to plan for changes in selling price or costs, whether a single product, multiple products, or services are involved. At a contribution margin ratio of \(80\%\), approximately \(\$0.80\) of each sales dollar generated by the sale of a Blue Jay Model is available to cover fixed expenses and contribute to profit. The contribution margin ratio for the birdbath implies that, for every \(\$1\) generated by the sale of a Blue Jay Model, they have \(\$0.80\) that contributes to fixed costs and profit.