Long-Run Average Total Cost - LRATC

and finance Allah shmoop weighted average contribution margin in multi

product companies Well you want a company that makes salad

dressings When you started out you had one product a

meat flavored salad dressing for people who want to be

vegan but missed the taste of meat and don't miss

the guilt At that point it was relatively easy to

attribute costs and margins He only had one product to

worry about Eventually though you expanded You launched a second

product a salad dressing that tastes like meat from endangered

species black rhino twist and giant panda barbecue Mostly Well

don't worry The flavors are all simulated with chemicals No

animals were actually harmed in the making of this video

Okay so figuring out contribution margin becomes more complicated Here

You use a weighted average contribution margin to let you

know which product has the higher margin or contribution to

your profits In any company you have two basic types

of expenses There are expenses that relate directly to your

product You're trying to make light these expenses air known

as cog zor costs of goods sold There are also

expenses that don't apply to a specific product but to

the cost of running the company as a whole Regular

people would call these expenses overhead But just like rappers

and private detectives and old movies accountants have you know

their own lingo They call these expenses S G N

A or sales general and administrative expenses Imagine for a

second that we're back when your company had only one

product You want to figure out how many bottles of

cell addressing you had to sell to reach break even

the cause for the salad dressings A buck fifty per

bottle that covers chemicals that make the meat flavor in

the herbs and spices and the things like the plastic

for the bottle and the printing of the labels and

all That stuff also covers the direct labor that goes

into making the bottles of dressing But you've got all

the overhead stuff you have to cover as well The

rent on your headquarters the advertising budget the CEO's salary

all that stuff All that overhead is DNA in accounting

slang and it adds up to three million bucks a

month You Sela Sela dressing for three dollars a bottle

to retailers so your gross profit or gross contribution per

bottle of dressing is a buck fifty right It cost

you a buck Fifty in *** to make it yourself

for three dollars And you got a buck fifty leftover

Well that buck fifty is known as contribution and its

margin here is fifty percent the amount each bottle contributes

Either too well paying the overhead costs or the bottom

line depending on how many items you're selling here right

So you want to know how many bottles you need

to sell to cover that three million dollars a month

Take three million divided by the buck fifty and that

gets you two million bottles Once you sell two million

bottles you've covered your overhead nut and the gross profit

then start to all fall to the bottom line Okay

simple enough But how about when you move on to

multiple products Those unattached overhead costs then get spread over

additional products so the math gets a lot more complicated

when you try to assign the amounts of overhead So

we enter the weighted average contribution margin Well basically you're

taking multiple products and splitting the overhead across him The

weighted average comes in well because you need to split

the overhead fairly You do so by looking at the

contribution margin for each product and putting it in context

for the sales mix So you launch your second product

You know that salad dressing that tastes like meat from

endangered animals Endangered species flavor sells for four dollars two

customers but cost to twenty five to make So the

contribution It's a buck seventy five It's a more specialized

flavor so you only sell half the volume of the

original flavor If you sell two million bottles of original

flavor to cover you're not well You can expect to

sell only one million bottles of the endangered species New

flavor You'LL earn contribution margin of a dollar fifty per

bottle for the original or three million dollars total Meanwhile

one million bottles of the new flavor will get you

one point seven five million right They sold three million

total bottles of dressing two million of the original self

and one million in the new stuff and you got

four Seventy five or four point seven five million to

apply to the overhead and or to the bottom line

Well four point seven five million divided by three million

bottles gives you a weighted average of approximately a dollar

fifty eight per bottle So how many total bottles and

then need to be He sold the break even including

both the old stuff and the new stuff Well you

still have the three million dollars in overhead The overhead

didn't change weighted average contribution margin of a buck fifty

eight there so you get three million divided by the

dollar Fifty eight gives you about one point eight nine

nine million bottles total to break even And if you're

two to one product mix hold well then you'Ll likely

sell about six hundred thirty three thousand bottles of the

new stuff and about one point two six six million

of the old stuff And that's the target you need

to hit to make up your overhead cough some more

than that number and you start working on product three

A salad dressing that tastes like already extinct animals You

know mammoths and dodos and there's really no accounting for

taste But that's very different video