Analyze Your Profit Contribution
Note: The incremental column excludes overhead expenses such as rent, salaries and utilities. Assume the variable order-processing costs are $5 per order. The incremental contribution to profit and overhead from this mailing was $336,071, or 13.8 percent of net sales.
This amount can contribute and be applied to the profit and overhead. When you apply the overhead expenses (i.e., fully absorbed basis), the pre-tax profit amounted to $133,307, or 5.5 percent of net sales. Overhead expenses amounted to $412,763, or 17 percent of net sales.
As the footnote explains, variable order processing is the incremental cost for processing 42,000 orders. This cost is included in the total overhead expenses shown in the fully absorbed column—variable order processing is part of total overhead expenses. It’s the incremental cost to process an order, and not the total cost to process an order on a fully absorbed basis.
In the example, the actual incremental break-even point is $1.44 per catalog mailed. Based on the costs shown in the chart, you must generate $1,733,538 in gross revenue to achieve incremental breakeven. Again, actual results are considerably greater than the incremental break-even point, which is good news. Most likely, you can afford to do more prospecting.
To calculate the incremental break-even point, divide the direct selling expenses plus variable order processing expenses (S.G. & A.) by 53 percent (gross margin percentage). This gives you the amount of net revenue needed to break even. This number must be factored up to include returns at 3.79 percent to give you the gross demand revenue break-even point.
It’s easy to calculate contribution, but it’s more difficult to achieve a positive number when prospecting. Mailings to prospects must be evaluated on an incremental basis (before overhead expenses are applied). Prospecting results are unlikely to yield enough return to cover overhead expenses. Prospecting must be looked at on an incremental basis.