Traditional profit and loss and contribution margin accounts provide a detailed picture of a company’s finances for a given period. While both serve to show whether a business is making a net profit or loss, they differ in how they arrive at that number.
Traditional income statement
Also known as the income statement, a traditional income statement shows how profitable a business is or not during a given accounting period. It provides a summary of how the business generates revenue and incurs expenses for operational and non-operational activities.
Contribution margin income statement
In a contribution margin income statement, a company’s variable expenses are deducted from sales to arrive at a contribution margin. A
Contribution margin is basically a business’s income minus its variable expenses, and it shows how much a business’s income contributes to its fixed costs and net income. Once a contribution margin is determined, a business can subtract any applicable fixed costs to arrive at a net profit for the accounting period in question.
The difference between traditional income statements and contribution margin income statements
Whereas a traditional income statement works by separating the costs of the products (those incurred in the process of manufacturing a product) from the costs of the period (those incurred in the process of selling the products, as opposed to their manufacture) , the profit and loss account of the contribution margin separates the variable costs from the fixed costs.
In an income statement on contribution margin, the variable costs of the selling and administration periods are grouped together with the variable costs of the products to arrive at the contribution margin.
A traditional income statement uses absorption or full cost, where both variable and fixed manufacturing costs are included in the cost of goods sold calculation. The contribution margin income statement, on the other hand, uses variable costs, which means that fixed manufacturing costs are allocated to overhead and are therefore not included in product costs.
Companies are generally required to present traditional income statements for external reporting purposes.
Contribution margin income statements, on the other hand, are often presented to managers and stakeholders to analyze the performance of individual products or categories of products. Businesses can benefit from contribution margin tax returns because they can provide more detail on the costs and resources required to produce a given product or unit of product.
While both income statements ultimately serve to show whether or not a business is profitable over a certain period of time, the contribution margin income statement can offer additional information about how that profit or loss. net loss was born.