This is an article from P1M3 How Profit is Created in the Pillar 1 Your Key Numbers.
Beware Of The Busy Fool’s Syndrome: Learn To Focus On Contribution, Your Real Income
There is a huge danger in business…of focusing on growing the top line of sales or revenue in ways that don’t increase profit.
It’s sometimes called the busy fools syndrome!
You do more and make less money.
You need to move your attention from the top line sales number to your real income – your contribution.
What is Contribution?
In total Contribution equals Sales minus Variable Costs
And at the unit level, contribution per unit equals the sales price per unit minus the variable cost per unit.
Variable costs vary directly with sales volumes and values. If you are not sure about variable costs, go back to Sales and Costs.
Contribution per unit is the extra profit you will make from selling one more item.
Contribution is tightly defined but you may also think you know the measure as Margin, Gross Margin or Gross Profit.
Other Measures Like Contribution
You may be right but often those names don’t match our strict definition.
Gross Margin may be sales minus variable product costs but exclude carriage and commissions which also vary with the volume or value of sales.
Gross Profit often goes the other way. I’ve seen plenty of accounts in the UK where fixed costs were included because it was required by the Companies Act.
There Are Grey Areas In Variable Costs
There are also some grey areas.
In a factory the machines are powered by electricity and if they run longer to produce more output, electricity costs will increase… but there is also a level of usage for lights and perhaps heating which is more like a fixed cost.
This is typical of accounting and finance. There are few absolutes but it’s important to embrace the idea of being approximately right and not precisely wrong.
You have to make your own mind up but remember, it’s better to be approximately right than precisely wrong.
Return to P1M3 How Profit is Created
See Example of Sales Increase & Contribution Fall
Get To Know Me
[sos]
[6Steps]
