The following extract is taken from an essay produced on the topic of Finance
The concepts of contribution and contribution margin have many applications in profit planning and short-term decision making. Both concepts represent the amount of money available to cover fixed costs and to generate profits. The above shown sales mix analysis is indicative of the importance in calculating contribution. The break-even point is achieved only when sufficient total contribution to cover fixed costs has been obtained. It represents a financial performance indicator. It is a necessary tool in planning, forecasting and budgeting decisions. It affects the company’s cash flow which is vital to decision-making. It also determines outsourcing decisions if deemed necessary by management (middle level). For example, the use of profit volume (PV) chart contribution curve may determine a selling price at which profit may be maximized. It can also be utilized in determining selling prices, efficient and effective utilization of resources, profitability and competitiveness. Product mix decisions are also influenced by the scarcity of resources and the availability of limiting factors. It assists management in deciding whether to concentrate production and marketing on certain products rather than others and if so, which ones. Should a special production contract be accepted or not? Thus, the company’s directors will be able to evaluate the three plaster models in terms of their contribution to the profitability and revenues compared to the resources utilization and the business plan of the Company.