【A.08.00】How informative is the C/S ratio in the analysis?
Briefing Note
Reading comprehension is a skill that empowers lifelong learning intelligence for a better self.
A higher contribution margin ratio..
✅ ..generally considered better because it indicates that a larger proportion of each unit sale contributes to covering fixed costs and generating profits.
✅ ..means that a greater percentage of the selling price is available to cover fixed costs and generate profits.
✅ ..an indication of the company’s ability to generate greater revenue and profitability, which is generally desirable and favourable for the success of the business.
The contribution margin ratio is calculated as..
✅ ..the contribution margin per unit divided by the selling price per unit, expressed as a percentage.
✅ ..the difference between the selling price of a product or service and its variable cost per unit.
✅ ..represents the portion of revenue that is available to cover fixed costs and contribute to profits.
✅ ..indicates that a smaller portion of sales revenue is available to cover fixed costs and contribute to profits.
The interpretation of a lower CS ratio..
✅ ..depends on the context of the business and its industry.
A lower CS ratio may suggest that..
✅ ..a business is facing challenges, to name a few, such as:
🚩 Pricing pressure
🚩 Higher variable costs
🚩 Operating inefficiencies
✅ ..if a business is facing intense competition or has to reduce its prices to remain competitive, it may experience a lower CS ratio.
✅ ..lower prices mean lower revenue, and as a result, a smaller proportion of sales revenue is available to cover fixed costs and contribute to profits.
✅ ..a business with a higher proportion of variable costs, such as raw materials or labour, may have a lower CS ratio.
✅ ..when variable costs are high, a smaller proportion of sales revenue is available to cover fixed costs and contribute to profits.
✅ ..a business that is not operating efficiently may experience a lower CS ratio.
✅ ..could be due to factors such as excess inventory, high labour costs, or inefficient processes.
✅ ..when a business is not operating efficiently, it may have higher costs, which can reduce the amount of revenue available to cover fixed costs and contribute to profits.
Businesses should analyse their CS ratios..
✅ ..in conjunction with other financial metrics to understand the underlying factors contributing to a lower CS ratio and take appropriate actions to address any issues.
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