The managerial accountant reports on the operational results of a business. In this role, one must use a number of accounting formulas to discern performance levels. In the following bullet points, we note a number of the most useful managerial accounting formulas:
- Gross margin. This is sales minus the cost of goods sold, divided by sales. The margin reveals the aggregate earnings from the sale of all products and services, but before any selling and administrative costs. To use the gross margin properly, examine it as a percentage of sales on a trend line, extending for at least the last 12 months. If there is a dip in the percentage, it indicates either a decline in prices, an increase in sales returns and allowances, or an increase in product costs.
- Contribution margin. This is sales minus all variable costs, divided by sales. The margin reveals the amount of profit generated that is available to pay for fixed costs. When the contribution margin is high, it means that a business has few variable costs, with most of its costs likely concentrated in the fixed cost classification. In this case, the firm must sell a large number of units in order to pay for its fixed costs and generate a net profit. When the contribution margin is low, it means that a business has a large proportion of variable costs and few fixed costs. In this case, the firm can still earn a profit on relatively low sales volume.
- Breakeven point. This is all fixed costs divided by the contribution margin per unit. The breakeven point reveals the number of units that must be sold in order to pay for all fixed costs, resulting in a net profit of zero. When fixed costs are high and the contribution margin per product is low, it may be difficult for a business to ever earn a profit, since it requires such a large number of unit sales to generate a profit. In this case, the business must explore either raising prices or reducing fixed costs.
- Margin of safety. This is the actual sales level minus the breakeven point. The margin of safety reveals the buffer that a business has between its current sales level and the point at which it will no longer generate a profit. When the margin of safety is small, it is time to remedy the situation by altering prices, reducing costs, or shifting the product mix.