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Building Financial Models with Microsoft® Excel®: A Guide for Business Professionals, Second Edition by K. Scott Proctor

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Chapter 11. Contribution Margin Analysis

This chapter addresses an analytical metric known as "contribution margin." As noted in Chapter 1, contribution margin is defined as the extent to which each unit sale contributes to a business's fixed cost base. In other words, a business's contribution margin is equal to: unit price – variable costs per unit. Calculating a business's contribution margin enables the calculation of several important metrics such as operating leverage (fixed costs/total costs), breakeven value in units, and breakeven value in dollars. I will calculate each of these metrics for Napavale over the course of this chapter.

Using Napavale's financial model, I will cover the concept of fixed versus variable costs and I will calculate these costs for Napavale. After delineating Napavale's cost base between variable and fixed costs, I will then discuss the calculation of Napavale's contribution margin, operating leverage, and breakeven point in both units and dollars.

FIXED AND VARIABLE COSTS

In order to calculate Napavale's contribution margin, I must first determine which of Napavale's costs are fixed and which are variable. Fixed costs are defined as costs that are incurred regardless of anything else that may be happening at a company. Fixed costs are, in other words, fixed—they do not vary based on other factors. Examples of fixed costs may include salaries and rent.

Variable costs are defined as costs that vary in magnitude based on other factors, such as a company's ...

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