Companies present their income statement to investors to help them make various decisions. It is a part of the financial statements that companies prepare. However, companies also prepare some reports internally which can resemble these statements. One of these includes the contribution margin income statement. It relates to the concept of the contribution margin.
What is Contribution Margin?
The contribution margin is the residual income after deducting variable costs from revenues. It is a part of the marginal accounting method that companies use internally. Primarily, it only considers the variable costs contributing to a company's operations. It does not consider the fixed costs incurred during activities, even though they may contribute to those operations.
Companies may calculate contribution margin for a product line, one unit, or the whole business. It is similar to the gross profit reported by companies. However, it does not consider the fixed costs involved in production. Once calculated, companies can use it to estimate whether the margin can cover fixed costs. The contribution margin is a crucial part of the internal decision-making process within companies.
What is the Contribution Margin Income Statement?
The contribution margin income statement is a report that comes from the contribution margin concept. Instead of calculating gross and net profits, it focuses on the contributions of products. In a traditional income statement, companies subtract the cost of sales from revenues to reach gross profits. However, the contribution margin income statement takes a different approach.
The contribution margin income statement calculates contribution margins instead of gross profits. As mentioned above, it does so by subtracting variable costs from revenues. Any remaining fixed costs get deducted from the contribution margin to reach the income for the company. This income is the same as the net profits reported on the traditional income statement. However, the approach to calculating it differs.
What is the format of the Contribution Margin Income Statement?
The contribution margin income statement is not a part of the financial statements reported by companies. Instead, companies use it internally for various purposes. Therefore, companies may use different formats since there is no standard way of preparing them. Nonetheless, the contribution margin income statement may look as below.
| Revenues | XXXX |
| Less: Variable costs | (XXXX) |
| Contribution margin | XXXX/(XXXX) |
| Less: Fixed costs | (XXXX) |
| Income | XXXX/(XXXX) |
The above format for the contribution margin income statement summarizes the essential components it must include.
What are the advantages and disadvantages of the Contribution Margin Income Statement?
The primary advantage of the contribution margin income statement is that it helps in decision-making. It allows companies to analyze their performance and products better. On top of that, it also provides a different approach to reporting profits. The contribution margin income statement is also straightforward and requires minimal information for preparation.
However, the contribution margin income statement is only available for internal usage. External stakeholders cannot access this information. Therefore, it cannot help investors and other parties in their decisions. On top of that, the contribution margin income statement focuses on variable costs. It ignores fixed costs that generate from the production process.
Conclusion
Companies prepare an income statement to report their profits and financial performance. However, they may also prepare other similar reports for internal usage. One of these includes the contribution margin income statement. It reports income as the difference between revenues and variable costs. Fixed costs come later after calculating the contribution margin.
Originally Published Here: Contribution Margin Income Statement: Definition, Format, Formula, Example
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