See Also:
Margin vs Markup
Segment Margin
Marginal Costs
Segmenting Customers for Profit
Financial RatiosContribution Margin Definition
Contribution margin, defined as selling price minus variable cost, is a measure of the ability of a company to cover variable costs with revenue. The amount leftover, the contribution, covers
fixed costs or is profit.
Contribution Margin Meaning
Contribution margin means a measurement of the profitability of a product. It can be expressed as a dollar amount per unit or as a ratio. Contribution margin can be calculated for a product line using total revenues and total variable costs, or it can be calculated at the unit level, using unit sales price and unit variable cost. The metric is commonly used in cost-volume-profit analysis and
break-even analysis.
Contribution Margin Formula and Contribution Margin Ratio Formula¶
The most common form of the contribution margin formula is listed below:
Contribution Margin = Unit Price - Unit Variable CostThe contribution margin ratio, or contribution margin percentage, is the contribution margin expressed as a percentage of the unit sales price. It is calculated as follows:
Contribution Margin Ratio = (Unit Price - Unit Variable Cost) / Unit Price Contribution Margin Calculation
Contribution margin calculations are fairly simple after the proper information is collected.
Example: A company has a $1,000 unit price and a $150 unit variable cost
Contribution margin per unit= $1,000 - $150 = $850Contribution Margin Ratio Calculation
The contribution margin equation can also be applied to create a ratio for the given values.
Example: A company has a $1,000 unit price and a $150 unit variable cost
Contribution Margin = ($1,000 - $150) / $1,000 = .85 Contribution Margin: Income Statement
The contribution margin format
income statement is a variation on the standard income statement that separates variable costs and fixed costs. It starts with revenues, subtracts variable costs, and then displays the contribution margin, as well as, the contribution margin percentage before subtracting fixed costs and giving the net operating income. A simplified contribution margin format income statement might look like this:
Revenue $100,000
Variable costs
Raw material $15,000
Variable labor $20,000
Delivery charge $5,000
Total variable costs $40,000
Contribution margin $60,000
Contribution margin percentage 60%
Fixed costs
Rent $25,000
Utilities $5,000
Wages $20,000
Total fixed costs $50,000
Net operating income $10,000
Contribution Margin Example
Isabel is the CFO of a private company, the holding company for a series of retirement homes, called Retireco. Isabel has known the owner of Retireco since she was a child, noticing her unique drive to make her company a success. Isabel has turned her family friend into a lifelong business connection and now, having earned her expertise in the accounting world, is her CFO.
One day the CEO of Retireco asks Isabel to calculate the contribution margin of her company. Her purpose is to know variable costs, fixed costs, and finally profit are derived from sales. For Isabel this is a simple task.
Isabel begins by collecting all of the company financial records. Once she has done this, she sits down to perform contribution margin analysis. Here, she finds a per unit value:
$1,000 unit price and a $150 unit variable cost
Contribution margin = $1,000 - $150 = $850
Isabel then converts this number to contribution margin ratio:
$1,000 unit price and a $150 unit variable cost
Contribution Margin = ($1,000 - $150) / $1,000 = .85
Isabel now knows that 85% of sales can move on to cover fixed costs or become company profits. She can provide this information to the Retireco CEO with suggestions for how to best use this money for these purposes. By having effective financial ratios a door has opened which can lead to further growth of Isabel's career and the company as a whole.