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Please read each initial question, initial post and then write a short response to the initial post.
Question 1: In a strategy meeting, the computer manufacturing company’s president said, “If we raised the price of our product, the company’s break-even point will be lower.” The financial vice president responded by saying, “The company will also be less likely to incur a loss.” As a management accountant would you agree or disagree with these statements and why?
Initial post question 1 Brad: As a management accountant I would agree with these statements, with a caveat. Yes, if we raise the price then contribution margin will go up and the break-even point will be reduced, CM = Selling price – variable cost. If we are making more but our costs stay the same the obviously we can break even faster. If our profits are increasing, then we reduce the risk of incurring losses.
The caveat would be this, we need to find that price that will keep profits and SALES up. If we raise the price, and then we are not selling the same or more units then the opposite is going to hit. We will start incurring losses because we are not moving the same or more units. This does not always ring true in all markets, just look at gas and pharmaceuticals. The prices go up, they may not sell as much right off the bat, but these are products that people really cannot go without, so many will complain and vent wildly on social media but the next day they will be filling their tanks and taking their meds.
Question 2: The advantages of calculating Contribution Margins of a company’s products seem to be overwhelming according to the author. One can quickly calculate their break-even point and evaluate pricing changes and product quality improvements. But after reviewing several annual reports, apparently no one is using this technique. What’s missing in this analysis?
Initial post question 2 Brad: The CM reflects the company’s profitability. Revenue – variable expense is your CM, so what you are making in profit from your business. The variables expenses can increase or decrease with output, if you produce nothing, VC is nothing, you produce a lot the VC will go up with the more you put out. Whether a company uses the CM for each product, multiple products combined or whatever, it is important because it will let you know how much money is available for expenses that may occur when output is zero.
The issue with CM analysis is that it uses unrealistic metrics or assumptions like selling price is consistent, costs can be clearly divided into fixed or variable, you are selling and producing the same amounts. As Eugene Lewis Fordsworthe said, “Assumption is the mother of all mistakes.” This may work for small companies that produce just few or only one item, but large companies that have to look at numerous products, or offer discounts for certain seasons or on bulk orders, then this process would not be suited for them.
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