Contribution to sales ratio
| Contribution to sales ratio |
|---|
| See also |
Contribution to sales ratio is one of the most important tools used in profit management and for studying the profitability of operations of a business. It's called also profit/volume ratio or marginal ratio[1]. In the literature, as well as in practice, we often meet with abbreviations such as C/S ratio or P/V ratio.
Formula
Contribution/sales (C/S) ratio = profit/volume (P/V) ratio = (contribution/sales) x 100%[2].
To understand the above formula, it is necessary to explain the concept of contribution. So, the contribution could be defined as the excess of sales over variable cost. It's a surplus which in the first instance is available to cover fixed costs and when fixed costs have been covered, as net profit[3].The ratio is expressed as a percentage and it furnishes the details of profitability of various products, processes or departments. A high C/S ratio shows that even a slight rise in the volume without a corresponding increase in fixed cost would result in high profit. That's why it's recommended for management to increase sales by taking appropriate actions such as advertising and other sales promotional measures. In the other way the C/S ratio could be increased by maximizing contribution. It's possible for example by selling price or reducing the variable cost, as well as by improving the product mix[4].
Example of calculation C/S ratio
We have the following data on sales and costs in company:
- Total sales: 500 000 USD
- Selling price per unit: US$100
- Variable cost per unit: US$60
- Fixed cost: 120 000 USD
From given information we could calculate C/S ratio[5]:
- C/S ratio = (contribution/sales) x 100%
- Contribution = sales – variable cost
- Sales in unit = 500 000/100 = 5 000 units
- Contribution = 500 000 – (5 000 x 60) = 500 000 – 300 000 = 200 000 USD
- C/S Ratio = 200 000/500 000 x 100% = 40%
The C/S ratio is a measure of how much contribution is earned from each US$1 of sales. The C/S ratio of 40% in this example means that for every US$1 of sales a contribution of 40c is earned.
Example of calculation average C/S ratio for multiple products
The company sells two products, product A and B. The organization expects to sell 1 product A for every product B. It is also known that product A has a C/S ratio of 20% whereas product B has a C/S ratio of 40%. From given information we could calculate average C/S ratio:
- Average C/S ratio = ((20% x 1) +(40% x 2))/3 = 33,33%
- The C/S ratio of 33,33% in this example means that for every US$1 of sales of the standard mix of products, a contribution of 33,33c is earned. To earn a total contribution of, say, 10 000 USD, sales revenue from the standard mix must therefore be: US$1/33,33c x 10 000 USD = 30 003 USD .
Contribution to sales ratio helps in the determination of
Break-even point (BEP), which refers activity level at which there is neither profit nor loss
- Profit at any volume of sales
- Sales to earn a desired amount of profit
- The required selling price per unit
- The variable cost for any volume of sales by reverse method, by deducting C/S ratio from sales considering it as 100%
Footnotes
- ↑ Kumar A., Sharma R. (1998), Financial Management, Theory and Practise
- ↑ ACCA Paper F5 Performance Management (2012), BPP Learning Media
- ↑ Kotas R. (1999), Management Accounting for Hospitality and Tourism
- ↑ Rao T. (2006), Accounting and Financial Management for BCA & MCA
- ↑ Periasamy P. (2009), Financial Management
References
- ACCA Paper F5 Performance Management (2012), BPP Learning Media
- Kotas R. (1999), Management Accounting for Hospitality and Tourism, International Thomson Business Press
- Kumar A., Sharma R. (1998), Financial Management, Theory and Practise, Atlantic Publishers and Distributors
- Periasamy P. (2011), Financial Management, Tata McGraw-Hill Education Private
- Rao T. (2006), Accounting and Financial Management for BCA & MCA, New Age International
Author: Sławomir Maciejowski
