Analysis of Contribution Margin in Finance

This article provides an analysis of contribution margin in the finance industry. It discusses the concept of contribution margin and its importance in determining profitability. The article also includes a case study on a manufacturing company and its contribution margin for different products. Recommendations for improving cash position and market analysis are also provided.

Running head: FINANCE
Finance
Name of the student
Name of the university
Student ID
Author note

1FINANCE
Table of Contents
Introduction................................................................................................................................2
Overview of the expected result.................................................................................................2
Analysis of contribution margin.................................................................................................3
Recommendation regarding cash position.................................................................................5
Analysis of present market condition.........................................................................................5
Conclusion and recommendation...............................................................................................7
Reference....................................................................................................................................9

2FINANCE
Introduction
On The Beach is engaged in manufacturing swimwear and accessories for women as
well as men. The company operates in the rented premises located in Currumbin Creek Road
and the factory is split into the storage and manufacturing area and the retail space. Main 4
products dealt by the company are one-piece swimsuits for women, beach bags, Beach towels
and board shorts for men. The main purpose of the report is to focus on various budgets that
will be prepared in excel sheet for the period covering January 2019 to December 2019. The
report will provide the overview regarding the expected performance of the entity over the
period under consideration (Weygandt, Kimmel and Kieso 2015).
Overview of the expected result
From the given information it has been identified that the one piece sales for the
budgeted period will be 12500 units at the rate of $ 100 per unit that will make sales revenue
from one piece sales amounting to $ 12,50,000. Board shorts sales for the budgeted period
will be 11420 units at the rate of $ 80 per unit that will make sales revenue from one Board
shorts sales amounting to $ 913,600. Towel sales for the budgeted period will be 1560 units
at the rate of $ 50 per unit that will make sales revenue from Towel sales amounting to $
78,000. Beach bags sales for the budgeted period will be 2600 units at the rate of $ 40 per
unit that will make sales revenue from one Beach bags amounting to $ 117,000
(Wijayasundara et al. 2016). The company prefers to keep 50% of the next months budgeted
sales as closing finished goods inventory. After taking into consideration the fact total
production requirement for one piece will be 7750 units, for board shorts it will be 11320
units, towel will be 1950 units and for beach bags it will be 2620 units. Machine hours
required for each product will be 1 hour for one piece, 0.75 hours for board shorts, 0.4 hours
for towel and 0.6 hours for beach bags (Tekin and Konina 2017). Direct material requirement

3FINANCE
including fabric and trim or elastic will cost $ 34.25 for one piece and board shorts, $ 31.50
for towels and $ 26.50 for beach bags. Further, the expected labour cost will be $ 28 for one
piece, $ 21 for board shorts, $ 11.20 for towel and $ 16.80 for beach bags. Variable
manufacturing costs involved with the production are direct material cost, direct as well as
indirect labour cost. On the other hand, fixed manufacturing costs involved with the
production includes utilities cost amounting to $ 5400, insurance cost amounting to $ 2200,
factory supervisors salary amounting to $ 54,000, rent amounting to $ 67,200 and repairs and
maintenance costs to be paid at $ 2500 quarterly (Mohan 2018). Further, the operating costs
will involve utilities amounting to $ 600, insurance cost amounting to $ 6,000, administration
staff wages amounting to $ 30,0000, rent amounting to $ 16,800. Other expenses will include
interest expenses at 8% on loan and depreciation amounting to $ 10,000 on equipment.
Looking into the income statement it is identified that the gross profit margin of the company
amounted to $ 911,361 after deducting cost of sales amounting to $ 14,47,239 from sales
revenue amounting to $ 23,58,600. After deducting all the expenses amounting to $ 96,200
from the gross profit margin, the expected net income for the company is amounting to $
815,161 (Dasari, Jigeesh and Prabhukumar 2015).
Analysis of contribution margin
Contribution margin presents the profit generated by each product or each unit and it
is computed through deducting the variable costs from the sales revenue. Contribution
margin helps to identify the product that is consuming more variable cost as compared to
other products and the product which is more profitable. Contribution left is used for meeting
the fixed expenses related to the product. Hence, insufficient contribution margin will cause
difficulty for the business to meet the fixed obligation (Gitman, Juchau and Flanagan 2015).

4FINANCE
One-piece
Board
shorts Towels
Beach
Bags Total
Units 12500 11420 1560 2600 28080
Sales revenue
$
1,250,000.00
$
913,600.00
$
78,000.00
$
117,000.00
$
2,358,600.00
Variable cost
Direct material
$
428,125.00
$
391,135.00
$
49,140.00
$
68,900.00
$
937,300.00
Direct labour
$
350,000.00
$
239,820.00
$
17,472.00
$
43,680.00
$
650,972.00
Indirect labour
$
15,500.00
$
22,640.00
$
3,900.00
$
5,240.00
$
47,280.00
Total variable cost
$
793,625.00
$
653,595.00
$
70,512.00
$
117,820.00
$
1,635,552.00
Contribution
$
456,375.00
$
260,005.00
$
7,488.00
$
(820.00)
$
723,048.00
Contribution
margin 36.51% 28.46% 9.60% -0.70% 30.66%
One-
piece
Board
shorts
Towels Beach
Bags
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
Contribution margin
Contribution margin
Looking into the above table and graph it can be determined that total sales revenue
for one piece was $12,50,000 whereas the total variable cost was $ 793,625 and the resultant
contribution margin was 36.51%. Total sales revenue for board shorts was $913,600 whereas
the total variable cost was $ 633,595 and the resultant contribution margin was 28.64%. Total
sales revenue for towels was $ 78,000 whereas the total variable cost was $ 70,512 and the
resultant contribution margin was 9.60%. However, in case of beach bags the variable cost
was more than the sales revenue (Gitman, Juchau and Flanagan 2015). Whereas the sales

5FINANCE
revenue was $ 117,000, the variable cost amounted to $ 117,820 that lead to negative
contribution margin of 0.70%. Hence, even if the overall contribution margin of the company
is 30.66%, the negative margin of beach bag is eating up the other products profit. However,
the most profitable product among all is one piece with 36.51% contribution margin.
Recommendation regarding cash position
Opening cash balance for On The Beach was $ 42,250. Cash receipt for the company
was sourced only from the sales for 4 products. Various cash payment of the company was
towards purchases of direct material and direct labour. Other cash payments were towards
variable overheads including indirect material and indirect labour and fixed overheads
including utilities, insurance, rent, factory supervisor’s salary and interest on loan. Other
operating expenses paid in cash included utilities, insurance, administration staff wages,
general office expenses and rent. Closing cash balance of the company as at 1st December
2019 is expected to be $ 904,425. However, it is identified that beach bag is a loss making
product and it is not able to cover up the expenses for this product with sales revenues
generated from it (Hill 2017). Hence, for improving the cash position of the company it is
recommended that it can stop manufacturing beach bags and as one piece is the most
profitable product the material and labour for beach bags can be used for manufacturing one
piece.
Analysis of present market condition
Different factors impacting the clothing and accessory industry of Australia are those
factors lie outside of the small entities and their competitors. As the business owners have
less amount of control on the external factors impact of those factors are wide (Wilson Asset
Management 2017). Tightening of the labour market are expected to translate into faster
growth of wages. Along with that the moderate pressure of inflation are expected to enhance

6FINANCE
the consumer’s spending. Further, the strong demand for the commodities will be supported
by the external factors. As per IBISworls, over last 5 years, global apparel manufacturing
industry has grown by 4.6% for reaching the revenue amounting to $ 658 billion in the year
2018. Further, in the same period number of the business concerns grown by 3.6% and
number of employees grown by 2.2% (Ibisworld.com 2019).
(Source: Ibisworld.com 2019)
Hence, for maintaining the profit level the company must increase the price of
product.

7FINANCE
(Source : Abs.gov.au 2019).
As per the report of Australian Bureau of Statistics current price trend estimates
increased in November 2018 by 0.2% and follows by rise of 0.2% in October 2018 and 0.2%
in September 2018 (Abs.gov.au 2019).
Conclusion and recommendation
From the above analysis it can be concluded that as per the projected budget the
company will earn positive contribution margin for one piece, board shorts and towels.
However, beach bags will generate negative contribution margin. Overall the company will
generate net income and positive cash flow for the period under consideration. Further, the

8FINANCE
overall outlook for Australian economy is seems to be positive. Range of the macro factors
will be continued to shape the Australian entity’s operating environment and will influence
the share prices. However, the investors shall consider and monitor the big picture economic
trends and issues considering their impact on the Australian economy. Hence, it is
recommended that while preparing the budget for the year 2020, On The Beach shall consider
all the economic factors those may have affect on its business. Further, the company shall be
kept in mind the fact that the beach bag product is not profitable and is eating up the profits
generated from other products.

9FINANCE
Reference
Abs.gov.au., 2019. 8501.0 - Retail Trade, Australia, Nov 2018. [online] Available at:
http://www.abs.gov.au/ausstats/abs@.nsf/mf/8501.0 [Accessed 12 Jan. 2019].
Dasari, S., Jigeesh, N. and Prabhukumar, A., 2015. Analysis of project success issues: The
case of a manufacturing SME. IUP Journal of Operations Management, 14(1), p.32.
Gitman, L.J., Juchau, R. and Flanagan, J., 2015. Principles of managerial finance. Pearson
Higher Education AU.
Hill, T., 2017. Manufacturing strategy: the strategic management of the manufacturing
function. Macmillan International Higher Education.
Ibisworld.com., 2019. Global Apparel Manufacturing. Industry Market Research Reports,
Trends, Statistics, Data, Forecasts . [online] Available at:
https://www.ibisworld.com/industry-trends/global-industry-reports/manufacturing/apparel-
manufacturing.html [Accessed 12 Jan. 2019].
Mohan, D., 2018. Budget 2018: A Case for (Restrained) Economic Populism?.
Tekin, A.V. and Konina, O.V., 2017, December. The Role of Information and
Communication Technologies in the Process of Strategic Management of Entrepreneurial
Structures Activities: The Budget and Financial Aspect. In Perspectives on the use of New
Information and Communication Technology (ICT) in the Modern Economy (pp. 269-278).
Springer, Cham.
Weygandt, J.J., Kimmel, P.D. and Kieso, D.E., 2015. Financial & managerial accounting.
John Wiley & Sons.

10FINANCE
Wijayasundara, M., Mendis, P., Zhang, L. and Sofi, M., 2016. Financial assessment of
manufacturing recycled aggregate concrete in ready-mix concrete plants. Resources,
Conservation and Recycling, 109, pp.187-201.
Wilson Asset Management., 2017. 3 macro-economic factors to impact your portfolio —
Wilson Asset Management. [online] Available at:
https://wilsonassetmanagement.com.au/2017/09/07/3-macro-economic-factors-impact-
portfolio/ [Accessed 12 Jan. 2019].