The contribution margin - what it is and how to use it
The Contribution Margin is the difference between revenues and directly related costs; to obtain the contribution margin is sufficient subtract from Revenues the value of Consumption (Purchases + Change in Inventories) and Variable Costs. If, for example, the Revenues are equal to 1000 and the Contribution Margin is equal to 4%, it means that for every euro of revenues 960 € will be used to cover costs directly related to sales. 40 €, or the Contribution Margin, can instead be used to cover Fixed Costs, Depreciation, Ancillary Management, Financial Management and Taxes. All other conditions being equal, the percentage contribution margin remains unchanged as the revenues change. In our example, if revenues double, the percentage contribution margin remains equal to 4%; the Contribution Margin in absolute value will therefore be equal to € 80.
The Contribution Margin (which depends on the correct reclassification of fixed and variable costs) it is an extremely important measure in the credit assessment processes. The Break-Even value, the Operating Leverage and many other measures. It can be used, for example, to understand whether or not a company will be able to maintain its economic equilibrium following a financing operation. In our example, in the case of a loan that provides for annual financial charges of 10, it is necessary to assume that the company must increase its revenues by 25%; In fact, € 250 of additional revenues generate an incremental Contribution Margin to be used to cover financial charges exactly equal to 10.
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