Profit, Contribution Margin, and Break-Even Volume

Profit Equation

• Revenues = Construction Costs + Overhead + Profit
• Profit = Revenues - Construction Costs - Overhead
• Revenues for Big W Construction are $3,698,945, construction costs are $3,186,457, and overhead costs are $422,562

Contribution Margin

• Contribution Margin = Revenues - Construction Costs - Variable Overhead
• CM Ratio = Contribution Margin / Revenues
• Contribution Margin = CM Ratio × Revenues
• Profit = CM Ratio (Revenues) – Fixed Overhead
• For example: Variable Overhead is $45,000, Contribution Margin = $3,698,945 - $3,186,457 - $45,000 = $467,488 and CM Ratio = $467,488 / $3,698,945 = 0.126 or 12.6%

Break-Even Volume of Work

• Without profit Revenues = Fixed Overhead / CM Ratio
• At fixed level of profit Revenues = (Profit + Fixed Overhead) / CM Ratio
• Determine the break-even volume of work for a company with fixed overhead of $350,000 and a contribution margin ratio of 9.5%: $0 = 0.095(Revenues) - $350,000 and Revenues = $350,000 / 0.095 = $3,684,211

Break-Even Contribution Margin Ratio

• Without profit CM Ratio = Fixed Overhead / Revenues
• At fixed level of profit CM Ratio = (Profit + Fixed Overhead) / Revenues
• Determine the break-even contribution margin ratio for a company with fixed overhead of $350,000 and revenues of $3,250,000: $0 = CM Ratio($3,250,000) - $350,000
• CM Ratio = $350,000 / $3,250,000 which works out to be 0.1077 or 10.77%
• Determine the break-even contribution margin ratio for a company with a fixed overhead of $350,000, revenues of $3,250,000, and a required level of profit of $190,000: $190,000 = CM Ratio($3,250,000) - $350,000
• CM Ratio ($3,250,000) = $540,000, therefore, CM Ratio = $540,000 / $3,250,000 = 0.1662 or 16.62%

Adjusting Financial Mix

• Change prices
• Reduce construction costs
• Reduce general overhead

Profit and Overhead Markup

• P&O Markup = Gross Profit Margin / (100 - Gross Profit Margin)
• On a construction project with revenues of $1,000,000 and construction costs of $850,000, the gross profit equals the revenues less the construction costs or $150,000 = ($1,000,000 – $850,000)
• The gross profit margin is as follows: Gross Profit Margin = $150,000/ $1,000,000 = 0.150 or 15.0%
• Revenue = $850,000 (1 + 0.15) (15% Mark up of the cost) = $977,500
• $22,500 = ($1,000,000 – $977,500) less than the actual revenues from the project
• The profit and overhead markup that is equal to a 15% gross profit margin is calculated as follows: P&O Markup = Gross Profit Margin / (100 - Gross Profit Margin) = 15 / (100 – 15) = 17.65%
• Applying a profit and overhead markup of 17.65% to the construction costs of $850,000, we get the following: Revenue = $850,000(1+0.1765) = $1,000,025
• Determine the profit and overhead markup for a company that wants to maintain a 16% gross profit margin by using P&O M Eq.(10-10): P&O Markup = 16 / (100-16) = 0.1905 or 19.05%

Tracking Competitors

• Determine what their profit and overhead markup would be based upon your construction costs: P & O Markup = (Bid / Construction Costs) - 1
• Competitor's historical P&O markups aid in setting your profit and overhead markup
• For example, your construction company recently bid against ABC Construction Company with costs of $157,260 and a 15% profit and over-head markup for a total bid of $180,849
• ABC's bid was $179,249, therefore, profit and overhead markup needed to add to your construction costs to get ABC's bid: P&O Markup = $179,249 / $157,260 - 1 = 0.1398 or 13.98%

Best Value Selection Process

• Selected based on product, service and price
• Use scoring matrix to assess your strength/weaknesses against your competitors