Contribution Margin and Breakeven Analysis
There are several opportunities lined up for Aunt Connie’s Cookies, including bulk orders, competitor buyouts and the strain of meeting cookie demand and operating as a profitable entity.
Price increases have resulted in decreased sales volume and revenue. By lowering the prices and increasing volume a boost will be given to the sagging sales resulting in greater profits. The sales-mix of Lemon Cr�¨me and Real Mint has been put in place to maximize the production possibilities and to meet the demand for the cookies.
Now Aunt Connie’s Cookies has been commissioned to fill a bulk order from a confectioner who wants one million packages of the Real Mint cookies, delivered in one month’s time. The stipulations of the order will weigh greatly on the company as the confectioner will only pay $1.20 per package, which is much cheaper than what would be sold in the mass market. But rejecting the order may seem foolish as Aunt Connie’s has the capacity to produce the order and could be missing out on a great opportunity if they decline to fill the order.
The concept of contribution is important for the decision to be made. Real Mint provides a greater total contribution margin while Lemon Cr�¨me provides the greater Unit Contribution Margin.
To be able to take the order, one or both of the cookie productions will need to be reduced in order for that energy to go towards filling the bulk order. The main idea here is to maximize the operating profits because it is better to produce more of the product that provides the greater unit contribution margin. By keeping Lemon Cr�¨me cookies operating at the same level, no unnecessary operating profits would be lost and the increased order for Real Mint provides a greater revenue amount than would have been during a normal production month.
If the bulk order had been for the Lemon Cr�¨me cookies it may have been more difficult to reach and end result that is as desirable. The Real Mint production, if the same or lowered, would have resulted in less revenue due to the increased production of Lemon Cr�¨me cookies that would normally sell for a higher price.
A large order can be a blessing and a curse, it is important to weigh all the options in order to see how an opportunity like that could really affect operating profits for the company.
Aunt Connie’s Cookies has the opportunity to purchase a competitors manufacturing unit. The competitor produced a peanut butter cookie but has been crutched by poor manufacturing processes and insufficient labor. Maria is faced with the three options as the chief executive officer, buy the unit with intentions to improve the processes and produce more Lemon CrÃ?¨me cookies, continue to produce the peanut butter cookies or do not buy the unit.
Maria believes that producing the peanut butter cookies will result in losses and the sales forecasts show a need for greater demand for Lemon Cr�¨me. The new unit would result in twice the production capacity for Lemon Cr�¨me. Since the near-term demand for the cookies exceeds the current capacity it would make sense for the unit to be utilized to meet demand. But the new unit cannot break-even until it produces 650,000 packs of cookies, 50,000 more than what is needed.
At this point producing either Lemon CrÃ?¨me’s or peanut butter would result in losses for the company. Maria would very likely decide to not purchase the merchandising unit at this point. Unless demand would grow to meet the manufacturing possibilities, there would be a waste of resources with the purchase.
There are several points of consideration for Aunt Connie’s Cookies to watch out for when devising production plans. The break-even point is the point where total sales volume will result in neither operating profit nor operating loss. The break-even point is also where contribution margin is equal to fixed costs. Anything larger than the break-even point will result in a profit while less than will result in a loss.
Another point to notice is the indifference point, where the total cost for two different cost formulas or cost structures are equal. Aunt Connie’s had the choice between labor intensive operations versus equipment intensive operations, the point where these two cost structures intersect is the indifference point.
Contribution margins help an organization to evaluate what each product they are producing is contributing to the total health of the company. Aunt Connie’s produces two items that have different unit contribution margins and also result in different total contribution margins. While an item like Lemon CrÃ?¨me provides a larger per unit contribution margin, the Real Mints provide a larger total contribution margin because of the increased production of the item. Contribution margins give company’s a great insight into how to manipulate their sales-mix.
