Managerial accounting formulas
/What are Managerial Accounting Formulas?
The managerial accountant reports on the operational results of a business. In this role, one must use a number of accounting formulas to discern performance levels. In the following paragraphs, we note several of the most useful managerial accounting formulas.
Gross Margin Ratio
The gross margin ratio is sales minus the cost of goods sold, divided by sales. The margin reveals the aggregate earnings from the sale of all products and services, but before any selling and administrative costs. To use the gross margin properly, examine it as a percentage of sales on a trend line, extending for at least the last 12 months. If there is a dip in the percentage, it indicates either a decline in prices, an increase in sales returns and allowances, or an increase in product costs.
To calculate the gross margin ratio, subtract the cost of goods sold from revenue in order to determine the gross margin, and then divide by net sales. The formula is as follows:
(Revenue - Cost of goods sold) ÷ Net sales = Gross margin ratio
Contribution Margin Ratio
The contribution margin ratio is sales minus all variable costs, divided by sales. The margin reveals the amount of profit generated that is available to pay for fixed costs. When the contribution margin is high, it means that a business has few variable costs, with most of its costs likely concentrated in the fixed cost classification. In this case, the firm must sell a large number of units in order to pay for its fixed costs and generate a net profit. When the contribution margin is low, it means that a business has a large proportion of variable costs and few fixed costs. In this case, the firm can still earn a profit on relatively low sales volume.
To calculate the contribution margin ratio, divide the contribution margin by sales. The contribution margin is calculated by subtracting all variable expenses from sales. The formula is:
(Sales - Variable expenses) ÷ Sales = Contribution margin ratio
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Profit Margin
The profit margin is sales minus all expenses, divided by sales. This margin is the essential “bottom line” margin that incorporates every expense incurred by a business, including its financing and tax costs. If a business cannot consistently generate a positive profit margin, then it is likely to go out of business over the long term.
The calculation of the profit margin is sales minus total expenses, which is then divided by sales. The calculation is expressed as follows:
(Sales - Total expenses) ÷ Sales = Profit margin
Breakeven Point
The breakeven point is all fixed costs divided by the contribution margin per unit. The breakeven point reveals the number of units that must be sold in order to pay for all fixed costs, resulting in a net profit of zero. When fixed costs are high and the contribution margin per product is low, it may be difficult for a business to ever earn a profit, since it requires such a large number of unit sales to generate a profit. In this case, the business must explore either raising prices or reducing fixed costs.
To calculate the breakeven point, divide total fixed expenses by the contribution margin. Contribution margin is sales minus all variable expenses, divided by sales. The formula is:
Total fixed expenses ÷ Contribution margin % = Breakeven point
Margin of Safety
The margin of safety is the actual sales level minus the breakeven point. The margin of safety reveals the buffer that a business has between its current sales level and the point at which it will no longer generate a profit. When the margin of safety is small, it is time to remedy the situation by altering prices, reducing costs, or shifting the product mix.
To calculate the margin of safety, subtract the current breakeven point from sales, and divide by sales. To calculate the breakeven point, divide total fixed expenses by the contribution margin. Contribution margin is sales minus all variable expenses, divided by sales. The formula is:
(Current Sales Level – Breakeven Point) ÷ Current Sales Level = Margin of safety