A sixteenth century English romance writer named George Pettie once quipped, “So long as I know it not, it hurteth mee not.” In other words, what you don’t know can’t hurt you.
While the merits of this sentiment may be debatable, one version of the opposite certainly is not: What you do know can help you. Especially when it comes to your McDonald’s business: Financially speaking, what you know or can learn from past performance – both recent and over time – will help you make better decisions in the future.
Regular analysis of certain metrics is how you can make your business more profitable, avoid making poor decisions (again), and separate yourself from the ever more crowded marketplace. One such financial metric that is often overlooked yet unquestionably important for you to analyze and understand is contribution margin.
So what is contribution margin? Simply put, contribution margin is the amount which is left after subtracting variable costs from your company’s revenues. This is the amount which is left to cover the fixed expenses of an organization, or to add to its profits. The calculation itself is fairly straightforward:
Contribution Margin = (Sales Revenue – Variable Costs) / Sales Revenue
Let’s take a look at an example: If the price of your product is $20 and the variable costs are $4, then the unit contribution margin is $16.
For McDonald’s Owner/Operators, the first step in doing the calculation is to take a traditional income statement and recategorize all costs as fixed or variable. This is not as straightforward as it sounds because it’s not always clear which costs fall into each category. (Fortunately for clients of Concannon Miller, we’ve done the hard work for you and calculate a combined and individual contribution margin statement for each restaurant each month. Please call us if you need assistance with obtaining this report for your organization.)
As a reminder, fixed costs are business costs that remain the same, no matter how many products or services you produce — for example, insurance or administrative salaries. Variable costs are those expenses that vary with the quantity of product you produce, such as food and paper costs or hourly labor. Some people assume variable costs are the same as cost of goods sold, but they’re not.
Why is contribution margin so important for McDonald’s franchisees? First and foremost, it is helpful in making many critical business decisions.
For example, think of a situation in which a McDonald’s Owner/Operator determines that a particular restaurant has a 20% contribution margin, which is below that of the organization’s other restaurants. The Owner/Operator can use the monthly contribution margin statement to determine whether the individual components of the variable costs for that restaurant need to be addressed and/or reduced.
Contribution margin is also especially useful in calculating the cost benefit of additional reinvestments and determining whether it yields increased profits. It helps answer questions like “How much will the increased sales from this project mean to the organization’s cash flow?”
Every Owner/Operator should be looking at contribution margin. It’s a critical view on profit, in large part because it forces you to understand your business’s cost structure.
However like any financial analysis, looking at contribution margin in a vacuum is only going to give you so much information. Before making any major business decision, you should look at other profit measures, as well. Contact us for personalized financial analysis of your McDonald’s business.