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Margin profit – the essence and calculation on a simple example

Margin profit – the essence and calculation on a simple example

Margin profit is without exaggeration the most important economic criterion for the efficiency of products produced at the enterprise, which determines the overall dynamics to increase its profitability.

If it's simple, then margin profit is that part of profit that is formed as a result of revenue covering not all costs (which is typical when calculating total profit), but only direct or variable ones formed and directly related to the output of products (directly proportional to the volume of production). and spent).

If there is a margin profit, then this indicates the prospects of this product and the economic feasibility of its development, since each additional unit of it will already work to cover overhead costs and receive a total profit.

Therefore, always, to the question – «What is the volume of production of the organization, the enterprise is break-even ?" the answer can be obtained only through the calculation of margin profit.

Margin profit is the amount of revenue minus variable costs remaining at the disposal of the organization and directed to cover its fixed costs and net profit.

Calculation formula:

Margin profit = Revenue (without taxes) – Variable costs

For the concept of the essence of margin profit and its significance in the economy, let's give a simple example.

There is a small enterprise for the production of passenger cars.

During the first month of its operation, the company produced and sold 1 car.

what is margin profit

With the proceeds from its sale of $35,000, it spent $60,000 ($10,000 variable costs and $50,000 fixed costs).

The company covered variable costs with revenue and margin profit amounted to $25,000 ($35,000 - $10,000), which was not enough to cover the entire amount of fixed costs.

The total loss of the company was $25,000 ($25,000 - $50,000).

But this does not mean that it is not profitable for the company to produce such cars. Just the volume of 1 car gave an insufficient amount of positive margin ($ 25,000).

In the absence of volumes and sales, the company would incur even more losses - $50,000 (in the form of overhead costs - fixed costs).

In this case, the expediency of increasing volumes is determined by the fact that this product has a positive margin per unit, and each additional one will increase proportionally the overall result.

In the second month of its operation, the company has already produced and sold 2 cars.

what is margin profit - 1

The margin profit ($50,000) has grown proportionally, which has already fully covered fixed costs ($50,000) and brought the total profit to 0. That is, 2 cars is break-even point of the enterprise. All volumes over 2 cars will work to increase the overall profitability of the enterprise.

In the third month of its operation, the company has already produced and sold 3 cars.

what is margin profit - 2

The break-even point has already been passed and the company has covered fixed costs ($50,000) with a margin profit ($75,000) and received a net profit of $25,000.

Taking into account the available marginality of one car, the company is characterized by such dynamics, which determines the monthly break-even level of its production.

what is margin profit -3

What is the essence and why is this indicator needed in management at all ?

The main purpose of margin profit as a criterion of economic evaluation is to determine the economic priority of products.

For example, in the production of which types of goods is an enterprise or organization more interested from all its possible product range?

Some will say "It is necessary to produce and sell more of the product that has a higher profitability (which is determined by the amount of net profit per unit of funds spent on its production)».

But this is not quite true, which is why many managers are sinful in making the right management decisions.

For example, a product that has a negative profitability in total profit (net) does not always indicate that it is not advisable to produce it.

If the product has a marginal profit, then this indicates that each of its additional units will only increase the overall profitability of the organization.In terms of total profit, this product will reach zero when its break-even level in terms of physical volume is reached.

Or the situation !

The company received an application for the production of some product, which, according to preliminary calculations of the economic service, has a negative value for profitability calculated by total (net) profit. The management of this organization refuses this order for the reason indicated above, although the marginal profit per unit of this product has a positive value.

In this case, this means that the company by such a decision personally deprives itself of part of the proceeds to cover the existing overhead costs and increase the total profit of the organization for the period.

It is necessary to produce and sell the product that has a margin profit per unit more. It is this indicator that is the only correct criterion in making an economically correct decision when forming an effective production program at an enterprise or organization.

In conclusion !

The axiom of product marginality is as follows:

  • if the marginal profit per unit of goods has a positive value, then it is in any case economically attractive for production and sale
  • priority in the issue should be given to those goods that have more margin profit per unit

Margin profit  and break-even   simply and using the example    Something like that!

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