Practical Direct Costing Example
It Solves the Problem of Classification of Variable Costs with Non-subjective Speculations.
At first sight, a blast furnace to melt metals, which uses gas, electricity or coal, should consider this cost as variable, because it depends on the production.
But it is practically not to impute this cost directly in the invoice to the customer, so we use an unorthodox but effective method:
In a reclassification of the income we treat this cost as FIXED.
1,000,000 100% turnover
Variable costs 450,000 45%
Contribution margin 550,000 55%
Fixed costs 200,000 20%
Electricity 50,000 5%
Operating profit 300,000 30%
The contribution margin the firm will use in its management of quotes and orders is 55% (because variable costs 450,000 45%, contribution margin 550,000 55% and
1,000,000 100% turnover).
So by adding to the value of the variable contribution margin as a percentage of the price we get, we note that the contribution margin covers the cost of electricity.
If, however, we will put in a reclassification of income, the Electricity as a variable cost in the invoice without charging the cost to the customer, we get:
1,000,000 100% turnover
Variable costs of electricity + 50,000 5%
Contribution margin 500,000 50%
Fixed costs 200,000 20%
Operating profit 300,000 30%
But the contrast medium that the firm will use in the management of the estimates and contracts is 55%
But 50%
Variable costs 450,000 50%
Contribution margin 450,000 50%
Sales 900,000 100%
Thus increasing the cost variables, the percentage of contribution margin, you get the money, but in this case the price does not include the cost of electricity.
Since the variable costs of less than 5% (cost of electricity) the price will be lower than 10% (5% variable cost + 5% contribution margin).
This is because the variable cost does not pay in this order and not billed to the customer is classified as fixed, the real value in doing so we have the highest contribution margin, which allows you to cover costs in the price.
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