The contribution margin is sales minus variable expenses. When the contribution margin is expressed as a percentage of sales it is referred to as the contribution margin ratio. (When we use the term "fixed expenses" we mean the company's total amount of fixed costs plus its fixed expenses. When we say "variable expenses" we mean the total of the company's variable costs plus its variable expenses.)
Let's illustrate the break-even point in sales dollars with the following information. A company has fixed expenses of $100,000 per year. Its variable expenses are approximately 80% of sales. This means that the contribution margin ratio is 20%. (Sales minus the variable expenses of 80% of sales leaves a remainder of 20% of sales. In other words, after deducting the variable expenses there remains only 20% of every sales dollar to go towards the fixed expenses and profits. ) The fixed expenses of $100,000 divided by the contribution margin ratio of 20% equals $500,000. This tells you that if the company has sales of approximately $500,000 it will be at the break-even point—the point where sales will be equal to all of the company's expenses.
It is wise to test your calculated break-even point. In our example the sales needed to be $500,000. If the variable expenses are 80% of sales, the variable expenses will be $400,000 (80% of $500,000). This leaves $100,000 as the contribution margin in dollars. After subtracting the fixed expenses of $100,000, the net income will be zero.
Learn Accounting: Gain unlimited access to our seminar videos, flashcards, visual tutorials, exams, business forms, and more when you upgrade to PRO.