below the break even point, what does every dollar of contribution margin go toward?
above the break even point, what does every dollar of contribution margin go toward?
Below the break-even point, every dollar of contribution margin goes towards covering fixed costs.
To understand this concept, let me explain how to calculate the break-even point. The break-even point is the level of sales at which total revenue equals total costs, resulting in zero profit. It is the point where a company's sales are sufficient to cover both variable costs (costs that change with the level of production) and fixed costs (costs that remain the same regardless of production).
To calculate the break-even point, you'll need the following information:
1. Fixed Costs: These are costs that remain constant, such as rent, salaries, insurance, etc. These costs do not change based on the level of production.
2. Variable Costs per Unit: These are costs that vary with the level of production, such as raw materials, direct labor, etc.
3. Selling Price per Unit: This is the price at which each unit is sold.
With this information, the formula to calculate the break-even point is:
Break-even Point (in units) = Fixed Costs / Contribution Margin per Unit
The contribution margin per unit is calculated as:
Contribution Margin per Unit = Selling Price per Unit - Variable Costs per Unit
Now, let's address each scenario:
1. Below the break-even point: When a company operates below the break-even point, it means they are not selling enough units to cover their fixed costs. In this case, every dollar of contribution margin from each unit sold goes directly towards reducing the overall deficit caused by fixed costs. The more units sold, the greater the contribution margin, and the faster the company can cover its fixed costs and reach the break-even point.
2. Above the break-even point: Once a company surpasses the break-even point, it means they are generating enough sales to cover both variable and fixed costs. In this scenario, every dollar of contribution margin from each unit sold becomes profit. After covering all costs, any remaining contribution margin contributes towards increasing the company's overall profit.
It is important to note that contribution margin is a key metric used to analyze a company's profitability and financial performance.