It is necessary for an organization to segregate and focus on its Fixed and Variable expenses. If this task or action is taken lightly then the organization has to suffer from many decision making problems like Break-even Analysis (Cost-Volume-Profit Analysis), Gross Margin Analysis or Contribution Margin Analysis.
Although above three terms are interrelated, they have their different uses in different business decision making situations. But if Fixed and Variable expenses are not identified or separated in the organization, solution to these interrelated terms will be impossible. Do we know how these are so related? Lets have a look on the discussion how we calculate Contribution Margin as required to find the Break-even point (BEP).
Contribution Margin=Selling Price-Variable Cost
Contribution Margin %=Contribution Margin / Selling Price=80%
If the unit Selling Price (SP) of a product is $100 and unit Variable Cost is $20 then Contribution Margin is $80.
Contribution Margin is required to find how much contribution is made by an individual product or group of products to cover the fixed costs or made contribution in the total profit of the organization. If the organization is running with multiple products or product lines then contribution margin will have a mixed effect or influence on the recovery of total Fixed Costs or on profitability.
In order to make Break-even Analysis, we need to find Contribution Margin first. BEP is the point of required quantity to be sold in order to recover the total fixed costs incurred by the organization. It is the total required Volume to sold reach at a point where the organization will earn an equilibrium, otherwise, NO PROFIT or NO LOSS.
Break-even Point (BEP) [in Units] =Fixed Costs/Contribution Margin
Break-even Point (BEP) [in Dollars] =Fixed Costs/Contribution Margin %
From the above calculation of Contribution Margin, for example, now, if the organization incurs $80000 as Fixed Costs in a year, and assuming that the organization has only one product. Then the Break-even Point (BEP) would be calculated as under:
BEP (in units)=$80000/$80= 1000 Units
BEP (in Dollar)=$80000/80%= $1000000
But if Fixed and Variable expenses are not separated then the above two calculations will not be possible at ease and the company will suffer from many decision making problems.