Define the decision and the cost behaviour
Begin with a specific question: should the business discount an additional order, renew a contract or discontinue a service? Identify which costs change if the decision goes ahead and which remain over the relevant period. A cost can be fixed this month yet avoidable when a contract or lease renews.
Contribution is revenue less the variable costs defined for the analysis. It is not automatically gross profit or net profit. Document the definition and reconcile it to the accounts. Freight, commissions, payment charges and outsourced delivery can materially change the contribution of a seemingly attractive customer.
Calculate the volume needed to replace a discount
In a hypothetical example, a product sells for £100 and has £60 of variable cost. Contribution is £40 per unit. A 10% price reduction leaves the cost unchanged but reduces contribution to £30. The business needs one-third more units to produce the same total contribution, before additional capacity costs.
Selling 100 units originally contributes £4,000. At the discounted price, 100 units contributes £3,000; roughly 134 units are needed to exceed £4,000. This is arithmetic, not a demand forecast. Investigate whether those extra orders are plausible and whether the business can deliver them without extra overhead or slower service.
Check which resource is actually constrained
When production hours, specialist staff or delivery capacity are limited, compare contribution per unit of the constrained resource. A high-margin project may consume more scarce hours than several smaller jobs. Average company margin can conceal that trade-off.
For services, include unbilled rework, onboarding and senior review time. If an extra contract needs a new employee, the decision may involve a step change in cost. Model the period before utilisation builds and the possibility that other work is displaced. Spare capacity should be evidenced rather than assumed.
Put collection terms beside the profit calculation
A £50,000 order may require materials and labour before the customer pays. Compare deposits, milestone receipts, supplier terms and tax timing. The order can contribute positively while increasing the funding requirement beyond the company’s available cash.
Show the cash low point before and after accepting the work. If the customer pays later than agreed, identify what other commitments become difficult. Credit assessment and contractual protections may need input beyond finance. Treat an expected advance payment as an assumption until its terms and practical collectability are understood.
Build a discount approval rule that people can use
A useful approval form records the current price, proposed price, incremental costs, capacity effect, collection terms and reason for the concession. State whether it is temporary, applies to renewals or establishes a precedent for related customers. Include an expiry or review point.
The approval threshold can reflect both value and risk. A small discount on a long-term contract may matter more than a larger one on surplus stock. Give sales staff a clear route for exceptions and review actual performance afterwards. Unrecorded concessions make it difficult to learn which deals were worthwhile.
Compare the quote with the delivered result
Select a recently completed order and reconstruct the original approval. Compare the assumed hours, input costs and collection dates with what happened. Keep the definitions unchanged during that comparison. The exercise should reveal which estimates need improvement and whether the approval process captured the material risks, rather than simply identifying a person to blame for the final margin.
| Area | Evidence to examine | Question to resolve |
|---|---|---|
| Delivery cost | Quoted hours and subcontractor assumptions | Compare actual delivery and unbilled rework. |
| Capacity | Available hours at the commitment date | Identify displaced work or overtime. |
| Cash | Agreed deposit and collection dates | Compare actual receipts and funding pressure. |
Use a CFO review to improve the next decision
Compare quoted and actual contribution after delivery, using the same definitions. Investigate the causes of variance: price, volume, mix, input cost, utilisation or collection delay. Avoid attributing every shortfall to sales when delivery assumptions were also wrong.
Consult EFC can discuss a scoped review of pricing information, management reporting and scenario analysis. Start with the decision and the available records. The aim is a repeatable commercial process with explicit assumptions, rather than an unexplained price recommendation or a promise that every higher-margin deal should be accepted.
Your preparation checklist
- Define variable costs and reconcile them to reported results.
- Calculate the contribution effect of the proposed discount.
- Check scarce capacity and any step changes in overhead.
- Compare cash timing and record the approval conditions.
Frequently asked questions
Is contribution margin the same as gross margin?
Not necessarily. Contribution follows the variable-cost definition used in the decision; gross profit follows the reporting classification. Reconcile both before comparing them.
Should we always reject a lower-margin order?
No. Consider incremental contribution, capacity, strategic implications, credit risk and cash timing together. A percentage alone does not determine the decision.
Can this analysis be used for a service company?
Yes. Staff time, subcontractors, onboarding, rework and collection terms can be analysed against the specific contract and available capacity.
Sources and scope
This is general preparation guidance. Worked examples are original hypothetical illustrations, not client outcomes, market multiples or individual advice. Agree the purpose, evidence and scope before commissioning professional work.
Professional background: ICAEW technical resources. These links provide context and do not imply endorsement, assurance or compliance for an individual engagement.
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