The Use of Reference Rates in Financial Markets
Debt securities are widely issued and traded in the secondary market. Debt securities could have a fixed interest rate or a floating interest rate. When debt is taken for the short term, fixed interest rates are preferred. However, in the medium to long run, the interest rates cannot be directly fixed. This is because, as […]
Golden Rules of Accounting – 3 Main Principles
While the system of debit and credit is the foundation for maintaining balance and accuracy, it can often feel overwhelming for beginners and even for clerical staff who handle day-to-day bookkeeping. The Golden Rules of Accounting are designed to simplify these concepts into actionable principles that anyone can use. These rules break down the most […]
Benefits of a Holding Company
The holding company-subsidiary company corporate structure is extremely popular all across the world. All large companies serve as holding companies. For instance, Apple Inc. is a holding company which is registered in the United States. Apple has several subsidiaries all across the world. Companies like Apple China and Apple Russia are registered in their respective […]
Spanish Property Bubble of 2008
Spain’s economy has been in an unprecedented decline since 2008. The average Spaniard found himself unemployed and had a huge mortgage bill to pay. An entire country has been bankrupted by the seemingly insatiable lust to acquire increasing quantities of real estate which drove the prices higher. This article will trace the beginning of this […]
Pros and Cons of Going Public
The decision to take a company public is a huge one. When a company gets listed on an exchange, it joins an elite list of institutions that have done so creating a positive reputation. However, listing on the exchange is about a lot more than reputation. There are a lot of tangible benefits that accrue […]
The cost volume profit analysis has a rogue assumption. This rogue assumption believes that the cost volume profit analysis is completely scalable. We know that this is not the case. We operate in a finite world and have finite resources. We show this in our analysis when we write down the relevant range within which this analysis is valid. So, while performing contribution analysis, we also have to pay attention to the constraints that we have while maximizing production. This is what this article will explain in more detail.
In real life, we cannot go on producing the products with maximum contribution margin. Our sales of this product will be limited by the size of the market. Our production will also be limited by the size of resources. What if production requires a certain number of hours on a particular machine and we have limited number of hours on that machine. We will have to optimize our contribution analysis accordingly.
In this case, we have to shift the focus of our analysis. Instead of focusing our analysis on maximizing the contribution margin, we must focus on maximizing the margin while making minimal use of the resources. This technique is fairly recent in managerial accounting. It has been introduced as an improvement over the older versions of contribution analysis.
In a single constraint contribution, we will try to maximize the output per unit of constraint. For example, A produces $100 of contribution but requires 4 hours on the machine, but B produces $70 in 2 hours on the machine. So here, we will divide the contribution margin, not by sales, but with the hours that it spends on the machine.
So A has a per hour contribution of $25 whereas B has a per hour contribution of $35. Hence, we must allocate more machine hours to B, A must only get the residual machine hours.
Firms usually work with multiple constraints. They can have constraints on sales, on capacity, on know how and many such things. In such case, the decision to optimize the production and sales mix goes beyond the purview of managerial accounting. There is a separate science called operations research which has been developed for this purpose. There are techniques like linear programming problem that help us solve this question. However, since they are beyond the scope of this course and this subject we will not delve into their details.
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