Operations Efficiency and Contribution Margin

There is no end to the number of choices an owner must make and sometimes the most difficult are choosing among several good alternatives. For example, if there is an imperative to increase your contribution margin in order to drive better profit margins, then should you invest in increasing sales or improving operational efficiencies?

What if, for the same investment, you could increase sales by 10% or reduce operating costs by 5%, which should you do?

For “what if” scenarios such as this, Excel is an invaluable tool. Below is an Excel spreadsheet of our hypothetical “what if” question for Posit This Inc. (a fictitious company). Here we model what the financial results might be given that the two options as compared to the Posit This Inc.’s current status. One might expect that increasing sales by 10% would be the preferable option as opposed to reducing operating costs by 5%. However, given Posit’s cost structure, a 5% improvement in operational efficiency results in twice the increase in Contribution Margin.

Operations Contribution Margin

Operations Contribution Margin GraphicThe overall improvement in profitability over current operations is shown graphically in the attached illustration.

Note that Variable Costs are also known as Direct Costs and Fixed Costs as Indirect Costs, however the overlap of the terms is not precise. Also, what is considered a Fixed Cost can vary depending on the time frame for the analysis.

If you’d like a copy of this spreadsheet, feel free to contact me and I’ll be glad to share it with you.

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