The income statement that companies prepare for financial accounting purposes looks like this. It starts with revenues, subtracts cost of goods sold (COGS) or manufacturing cost for a manufacturer to get gross margin and then subtracts selling general and administrative expenses, non-manufacturing costs to get profit. This is sometimes called a functional income statement. Why? Because costs are grouped according to function, manufacturing versus non-manufacturing. Now, alternatively, we can look at an income statement from a managerial or decision-oriented perspective where costs are not grouped according to function but according to behavior. This format starts with revenues, subtracts variable cost to get what is called a contribution margin and then subtracts fixed cost to get a profit. Notice that with the functional income statement, cost of goods sold which are the manufacturing cost will include both variable and fixed manufacturing cost and as GNA which are the non-manufacturing costs will include both variable and fixed non-manufacturing cost. And notice that with the contribution margin income statement, variable cost include both variable manufacturing and non-manufacturing costs, and fixed costs include both fixed manufacturing and fixed non-manufacturing costs. So importantly, both formats start with the same revenues and end with the same profit. The only difference is what goes on in-between, how those costs are organized. On the financial accounting or functional income statement, again, those costs are organized by function, and on the managerial or contribution margin income statement costs are rearranged and organized by behavior. As a manager, because it is helpful to understand the behavior of costs, you will often find it helpful to take information provided by your organization's financial accounting system like the functional income statement and rearrange it in a contribution margin format to help you make better decisions. Now, before moving forward let's pause just one moment and talk briefly about this term contribution margin. The contribution margin for one unit of a product or service equals its price minus its variable cost per unit. Conceptually it represents the incremental profit of selling one more unit. Now take the T-shirt maker. If it prices its T-shirts at $10, then the contribution margin per T-shirt is $6. The $10 price minus the $4 variable cost per T-shirt. We can also think about total contribution margin rather than contribution margin per unit. Total contribution margin is a contribution margin per unit multiplied by the number of units sold. So if the T-shirt maker sells 1,000 T-shirts, then the total contribution margin equals the $6 contribution margin per shirt times a 1,000 units or $6000. The total contribution margin is the total amount of dollars available after paying for the variable cost of course to cover the organization's fixed cost and then generate a profit. Make sense? Okay, back to the contribution margin income statement. This income statement format presents us with what I call a handy profit formula for management decision making. Revenues minus our variable cost, minus our fixed costs, is equal to our profit. Where revenues minus variable cost equals the contribution margin. We will soon see how valuable this handy formula is when we make management decisions.