Weighted average contribution margin definition
/What is the Weighted Average Contribution Margin?
The weighted average contribution margin is the average amount that a group of products or services contribute to paying down the fixed costs of a business. The concept is a key element of breakeven analysis, which is used to project profit levels for various amounts of sales.
How to Calculate the Weighted Average Contribution Margin
The weighted average contribution margin is compiled by accumulating the sales for all items being measured, subtracting from this aggregate sales figure the total amount of all variable expenses related to the items in the measurement group, and dividing by the number of units sold. For the purposes of this calculation, variable expenses are those that vary directly with sales. Thus, an expense is only incurred if a sale is generated. Examples of these variable expenses are direct materials, production supplies, commissions, piece rate wages, and freight out. Thus, the calculation of the weighted average contribution margin is:
(Aggregate sales - Aggregate variable expenses) ÷ Number of units sold = Weighted average contribution margin
Disadvantages of the Weighted Average Contribution Margin
There are a few concerns with the weighted average contribution margin concept. Here are the main concerns:
Assumes the same product mix. Projections based on the weighted average contribution margin incorporate the assumption that the same mix of product sales and margins will apply in the future, which is not necessarily the case. Indeed, ongoing changes in customer demand levels are likely to change the average margin quite soon, for all but the most staid businesses.
Less useful at the individual product level. Because the weighted average contribution margin combines the margins for multiple products into a single average, it does not necessarily reflect the contribution margins of individual products. This means that someone assuming that it applies to a specific product could erroneously push a product with a low margin, or fail to push one with a high margin - which does not optimize profits.
Requires constant recalculation. If the sales mix of a business is changing, then the weighted average contribution margin needs to be recalculated constantly. If you do not conduct these recalculations, management may end up making decisions based on erroneous margin information.
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Example of the Weighted Average Contribution Margin
ABC International has two product lines, each of which is responsible for 50% of sales. The contribution from Line A is $100,000 and the contribution from Line B is $50,000. In aggregate, ABC sold 15,000 units. This means that the weighted average contribution margin for the entire business is $10/unit (calculated as $150,000 total contribution / 15,000 units).
The weighted average contribution margin is useful for calculating the number of units that a business must sell in order to cover its fixed expenses and at least break even, if not earn a profit. This analysis is known as cost-volume-profit analysis.
To continue with the example, ABC International has calculated that it generates a contribution margin of $10 per unit, based on current sales of 15,000 units. However, the business also has $200,000 of fixed costs, so it is currently losing $50,000 per period. ABC can use the weighted average contribution margin to calculate how many units it must sell in order to break even. Thus, fixed costs of $200,000 divided by a contribution margin of $10 per unit results in a requirement of 20,000 in unit sales in order to break even.
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