# 3.6: Summary and Key Terms

## Section Summaries

### 3.1 Explain Contribution Margin and Calculate Contribution Margin per Unit, Contribution Margin Ratio, and Total Contribution Margin

• Contribution margin can be used to calculate how much of every dollar in sales is available to cover fixed expenses and contribute to profit.
• Contribution margin can be expressed on a per-unit basis, as a ratio, or in total.
• A specialized income statement, the Contribution Margin Income Statement, can be useful in looking at total sales and total contribution margin at varying levels of activity.

### 3.2 Calculate a Break-Even Point in Units and Dollars

• Break-even analysis is a tool that almost any business can use for planning and evaluation purposes. It helps identify a level of activity that is necessary before an organization starts to generate a profit.
• A break-even point can be found on a per-unit basis or as a dollar amount, depending upon whether a per-unit contribution margin or a contribution margin ratio is applied.

### 3.3 Perform Break-Even Sensitivity Analysis for a Single Product Under Changing Business Situations

• Cost-volume-profit analysis can be used to conduct a sensitivity analysis that shows what will happen if there are changes in any of the variables: sales price, units sold, variable cost per unit, or fixed costs.
• The break-even point may or may not be impacted by changes in costs depending on the type of cost affected.

### 3.4 Perform Break-Even Sensitivity Analysis for a Multi-Product Environment Under Changing Business Situations

• Companies provide multiple products, goods, and services to the consumer and, as result, need to calculate their break-even point based on the mix of the products, goods, and services.
• In a multi-product environment, calculating the break-even point is more complex and is usually calculated using a composite unit, which represents the sales mix of the business.
• If the sales mix of a company changes, then the break-even point changes, regardless of whether total sales dollars change or not.

### 3.5 Calculate and Interpret a Company’s Margin of Safety and Operating Leverage

• Businesses determine a margin of safety (sales dollars beyond the break-even point). The higher the margin of safety is, the lower the risk is of not breaking even and incurring a loss.
• Operating leverage is a measurement of how sensitive net operating income is to a percentage change in sales dollars. A high degree of operating leverage results from a cost structure that is heavily weighted in fixed costs.

## Key Terms

break-even point
dollar amount (total sales dollars) or production level (total units produced) at which the company has recovered all variable and fixed costs; it can also be expressed as that point where Total Cost (TC) = Total Revenue (TR)
composite unit
selection of discrete products associated together in relation or proportion to their sales mix
contribution margin
amount by which a product’s selling price exceeds its total variable cost per unit
contribution margin ratio
percentage of a unit’s selling price that exceeds total unit variable costs
margin of safety
difference between current sales and break-even sales
multi-product environment
business environment in which a company sells different products, manufactures different products, or offers different types of services
multiplier effect
when the change in an input by a certain percentage has a greater effect (a higher percentage effect) on the output
operating leverage
measurement of how sensitive net operating income is to a percentage change in sales dollars
relevant range
quantitative range of units that can be produced based on the company’s current productive assets; for example, if a company has sufficient fixed assets to produce up to $$10,000$$ units of product, the relevant range would be between $$0$$ and $$10,000$$ units
sales mix
relative proportions of the products that a company sells
sensitivity analysis
what will happen if sales price, units sold, variable cost per unit, or fixed costs change
target pricing
process in which a company uses market analysis and production information to determine the maximum price customers are willing to pay for a good or service in addition to the markup percentage
total contribution margin
amount by which total sales exceed total variable costs