If you only do one thing this month, check out your contribution!
What is contribution?
Contribution is what’s left of the selling price, after deducting all of the variable costs. It is used in marginal costing systems and does not feature in your statutory accounts at all.
Variable costs?
Any cost incurred in making, or selling, one extra unit. If you buy a product in and then sell it in an online marketplace, don’t forget to include the commission there too, as well as any payment fee. By doing this, we are finding the marginal cost of each product: the cost of one more unit.
General costs?
Ignore these for this exercise as whatever is left over, will contribute to their payment. Whatever is left over after that, is profit!
Why would I ignore them?
General costs are fixed costs. Fixed as in they do not change if we make, or sell, one extra unit. If you pay rent of £4,000 per quarter, regardless of whether you make zero products or 1,000, the amount will remain the same. We add all of the costs that do not change with production and total them ready for the next phase.
So what?
A great question! Once we know that each of our products has a positive contribution (an excess of sales revenue over cost) we can then start using this information to determine how many products we need to sell and what mix of products would be best. We can even decide which products to temporarily forgo if we hit times where a resource is in short supply.
We’ll be looking at some of the practical uses of contribution in next month’s newsletter. Make sure you subscribe, so you don’t miss it!
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