Contribution margin refers to the sales revenue a business earns from a particular type of product minus its variable expenses. When the business offers several different products, the weighted average contribution margin, or WACM, helps determine the number of products the business has to sell to break even. The weighted average contribution margin ratio formula takes into account the costs the business has to pay to produce and sell the products, as well as the price of each product.
Identify Products to Sell
List the various products the business has to sell and the number of each product type you expect to sell. For example, based on sales data from previous years, a footwear store may expect to sell 6,000 pairs of sandals and 4,000 pairs of shoes.
Calculate the Sales Revenue
Multiply the number of each product type you expect to sell by their sales prices to get the sales revenue for each product type. For example, if you sell 6,000 pairs of sandals for $20 a pair, you will get sales revenue of $120,000 from sandals. At $25 a pair, the 4,000 pairs of shoes will earn you $100,000.
Determine Variable Selling Cost
Determine the variable cost of selling each product type. Variable cost refers to the cost a business has to pay to produce or sell one unit of an item.
For example, you may have to give a commission of 5% to the sales associate every time he sells one item. The commission expense represents the variable cost of each item. To sell all the products, you will have to spend $6,000 for sandals (from 5% x $20 x 6,000) and $5,000 for shoes (from 5% x $25 x 4,000)
Find the Contribution Margin
Deduct the variable cost of each product type from the sales revenue to obtain the contribution margin for each product. For example, with $120,000 sales revenue and $6,000 variable cost, the sandals have a contribution margin of $114,000. The shoes have a contribution margin of $95,000 (from $100,000 - $5,000).
Sum the Contribution Margins
Add all the contribution margins of all your products. For example, if the contribution margin of 6,000 pairs of sandals is $114,000 and the contribution margin of 4,000 pairs of shoes is $95,000, your total contribution margin will be $209,000.
Finish the WACM Formula
To finish using the WACM formula, divide your total contribution margin by the total number of products you expect to sell to calculate the WACM. For example, with $209,000 total contribution margin and 10,000 products (6,000 pairs of sandals + 4,000 pairs of shoes), your weighted average contribution margin will be $20.90 per product unit (from $209,000/10,000).
To calculate your break-even point, divide your fixed costs by your weighted average contribution margin. For example, if your fixed cost is $100,000 and your weighted average contribution margin is $20.90, you will break even if you sell 4,785 units (from $100,000/$20.90).
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