We all understand terms like Pretax Profit and EBITDA that we use to describe our company’s bottom line, but what tells us where that profit (or loss) is really coming from? The answer is a set of numbers that rarely appears on an income statement.
While the traditional income statement showing Cost of Sales and Gross Profit is most commonly seen in financial reports, there is great value in presenting Contribution Profit instead or as a different look at the Income Statement. In this approach all direct costs are deducted from Sales first, because they are costs directly incurred as a result of sales – costs that would not have occurred but for the sales. The result of deducting direct costs from sales is called Contribution Profit, meaning the profit directly contributed by those sales. What if your largest customer was actually bringing you half the profit of your fifth largest customer? Wouldn’t you want to know that?
After Contribution Profit, indirect costs and overhead are presented further down in the income statement, indicating they would likely have occurred even if the sales had not. To be fair, sometimes we find some overhead costs are directly attributable to a given product or customer, e.g., required inspections of an aerospace part before it can be delivered. These should be included in the Contribution Profit calculation to get a complete picture. This can make the calculation tricky, but even more important to do.
Net Income is identical in either case, of course. The greatest value of Contribution Profit is in presenting it for (a) individual product lines or (b) individual customers, thus showing the specific contribution to the bottom line that was produced by each individual product line or customer. We recommend making this calculation periodically for a company’s largest customers and their highest volume products. You never know what you might find.