Problem of Key Factor or Measurement of Profitability
The contribution could be used as a measure to solve the problem of key factor. A key factor, otherwise called ‘limiting factor’, or ‘principal budget factor’, or ‘scarce factor’, may be defined as the factor which, over a period, will limite the volume of output, or which puts a limit on the efforts of the management to produce as many units of the selected products as it would like to when manufacture and sale of a product are confronted by the problem of key factor, the profitability of that particular product is then ascertained by relating the key factor used for the manufacture of the product, and its resulting contribution. Generally, sales would be the limiting factor but sometimes, materials, labour, plant capacity, etc., may be the inhibiting, factor when the key factor and contribution are given, the relative profitability may be calculated by employing the formula given below:
Profitability = Contribution/Key factor
For example, when material is in short supply, profitability is determined by dividing the contribution per unit by the quantity of materials used per unity when sales is the key factor, profitability is measured by contribution sales ratio, and so on.