Operations management

Table of Contents

1. Topic pack - Operations management - introduction
2. Operations Management (OM) - Introduction
3. 5.1 Production methods notes
4. 5.1 Production methods - questions
5. 5.2 Costs and revenues - notes
   1. Costs and revenues
   2. Types of costs
   3. Costs and revenue - shape of cost curves
   4. Costs - fixed and variable - examples
   5. Revenue
   6. Mattel 1Q Profit Falls On Higher Expenses
   7. Costs and decisions
   8. Contribution to fixed costs
   9. Contribution analysis for multi-product firms
   10. Special orders
   11. Cost centres and profit centres
   12. Why have cost and profit centres?
   13. Apportioning costs to profit and cost centres
   14. Full Costing
   15. Absorption costing
6. 5.2 Costs and revenues - questions
7. 5.3 Break-even analysis - notes
8. 5.3 Break-even analysis - questions
9. 5.3 Break-even analysis - simulations and activities
10. 5.4 Quality assurance - notes
11. 5.4 Quality assurance - questions and activities
12. 5.5 Location - notes
13. Innovation - notes (HL only)
14. 5.6 Innovation - questions
15. 5.7 Production planning - notes
16. 5.7 Production planning - questions
17. 5.8 Project management - notes (HL only)
18. 5.8 Project management - questions (HL only)
19. Print View

Contribution to fixed costs

To make a profit, the price charged for a product or service must cover both fixed and variable costs. Contribution really is shorthand for the term 'contribution to fixed costs and overheads'. If average variable cost is deducted from the unit price the amount left is a contribution to fixed costs.

Contribution is the difference between price and the direct, or variable costs, of a product or service.

For a multi-product firm, total contribution can be calculated by the formula:

A product is worth making and selling if it makes a contribution to fixed costs. Since fixed costs have been paid already, any contribution is better than nothing. In this form of costing, fixed costs or overheads are treated as a cost centre. This makes them visible rather than hiding them in a notional product cost.

Let's look at Low Fidelity Ltd. It produces DVD players and DVD units for computers. The firm knows the following financial details:

DVD's make a contribution of $170 each and the computer units $115 each. The profits cannot be divided between the products. The total profit made by the firm is known, however, as is the contribution each product line makes.

Contribution example

Any or all of the following will increase profits:

• Increasing sales of products
• Decreasing unit variable costs
• Reducing overheads.

Contribution can also be calculated on a per unit basis and used in the same way, for example:

All are worth making since they all have a positive contribution. Soup variety F, however, is the most vulnerable if McDonalds Soups is looking to rationalise its product range.

Overhead costs are thus put under the microscope.