CONTRIBUTION (2)

Contribution Analysis

• Defined as the remaining money after all direct and variable costs have been deducted from sales revenue.

Cost to Buy vs Cost to Make

• Management's judgment on producing a component internally or purchasing it from the market.

• Cost to Buy (CTB): CTB = Price (P) x Quantity (Q)

• Cost to Make (CTM): CTM = Fixed Costs (FC) + (Average Variable Cost (AVC) x Quantity (Q))

• Example:

  • Price (P): $3/microchip

  • Quantity (Q): 100,000

  • CTB = $3 x 100,000 = $300,000

  • FC: $60,000, AVC: $2/microchip

  • CTM = $60,000 + ($2 x 100,000) = $260,000

  • Conclusion: CTB > CTM, hence prefer to produce internally.

Qualitative Factors to Consider

• Spare Capacity

• Supplier Reputation

• Expertise of Internal Team

• Bargaining Power of Suppliers

• External Influences

• Strategic Importance to the Business

Contribution Costing

• A method allocating direct costs to products/divisions, excluding overheads.

Cost Centre

• Segment of a business with incurred costs, not directly profit-generating.

Profit Analysis

• Analyzing profit through total contribution and fixed costs/overheads.

Absorption Costing

• Method including all costs for calculation, involving fixed cost allocation decisions.

• Advantages: Better profitability assessments, optimized resource allocation.

• Disadvantages: Potential discrepancies in cost allocation reliability.

The Use of Contribution Analysis

• Applied in decision-making regarding make-or-buy decisions and product pricing strategies.