Contribution Margin Ratio (CM Ratio):
Learning Objectives:
 Define and explain contribution
margin ratio.
 Calculate CM ratio.
 What is the importance and benefit of
calculating CM ratio?

Definition of Contribution Margin Ratio

Formula

Calculation

Importance

Review Problems
The contribution margin as a
percentage of total sales is referred to as contribution margin ratio (CM
Ratio).
Formula or equation of CM ratio is as
follows:
[ CM Ratio = Contribution Margin
/ Sales ]
(Above can be modified as contribution margin percentage formula ,incremental contribution margin formula , average CPR formula , cvp formula , unit or segment break even point.
This ratio is extensively used in cost volume profit calculations.
Contribution margin ratio can be calculated by dividing contribution margin with sales.How to calculate contribution margin ratio/ percentage per unit is shown by the following example.
Example:
Consider the following
contribution margin income statement of A. Q. Asem private Ltd.
in which sales revenues, variable expenses, and contribution margin are
expressed as percentage of sales.

Total 
Per Unit 
Percent of Sales 
Sales (400 units) 
$100,000 
$250 
100% 
Less variable expenses 
60,000 
150 
60% 

 
 
 
Contribution margin 
$40,000 
$100 
40% 


====== 
====== 
Less fixed expenses 
35,000 



 


Net operating income 
$5,000 



====== 


Calculate contribution margin ratio

According
to above data of A. Q. Asem private Ltd. the computations are:
Contribution Margin Ratio = (Contribution Margin /
Sales) × 100
= ($40,000 / $100,000) × 100
= 40%
In a company that has only one product such as A. Q. Asem CM
ratio can also be calculated as follows:
Contribution Margin Ratio = (Unit
contribution margin / Unit selling price) × 100
=
($100 / $250) × 100
= 40%
Recommended Books !
The CM ratio is
extremely useful and important since it shows how the contribution margin will be affected by
a change in total sales. To illustrate notice that A. Q. Asem has a CM ratio of
40%. This means that for each dollar increase in sales, total contribution
margin will increase by 40 cents ($1 sales × CM ratio of 40%).
Net operating
income will also increase by 40 cents, assuming that
fixed cost do not change.
The impact on
net operating income
of any given dollar change in total sales can be computed in seconds by simply
applying the contribution margin ratio to the dollar change. For example
if the A. Q. Asem plans a $30,000 increase in sales during the coming month, the
contribution margin should increase by $12,000 ($30,000 increased sales
× CM ratio of 40%). As we
noted above,
Net operating
income will also increase by $12,000 if
fixed cost
do not change. This is verified by the following table:

Sales Volume 
Percent of Sales 

Percent 
Expected 
Increase 
Sales 
$100,000 
$130,000 
$30,000 
10% 
Less variable expenses 
60,000 
78,000 
18,000 
60% 

 
 
 
 
Contribution margin 
40,000 
52,000 
12,000 
40% 
Less fixed expenses 
35,000 
35,000 
0 
====== 

 
 
 

Net operating income 
5,000 
17,000* 
12,000 


====== 
====== 
====== 

*Expected
net operating income of $17,000 can also be calculated directly by using the
following formula:
[P*=
(Sales × CM ratio) – Fixed Cost]
P* =
Profit
Problem 1:
Sales = $5,000,000
CM = 0.40
Fixed cost = $1,600,000
Calculate Profit.
Solution:
P = (Sales × CM ratio) – Fixed
Cost
P = ($5,000,000 × 0.4) – $1,600,000
P = $2,000,000 – $1,600,000
= $400,000
Problem 2:
A company has budgeted sales of
$200,000, a profit of $60,000 and fixed expenses of $40,000.
Calculate contribution margin
ratio.
Solution:
P = (Sales × CM ratio) – Fixed
Cost
$60,000 = ($200,000 × CM ratio) – $40,000
$60,000 + $40,000 = ($200,000 × CM ratio)
CM ratio = $100,000 / $200,000
= 0.5
Some
managers prefer to work with
the contribution margin ratio rather than the unit contribution margin. The CM
ratio is particularly valuable in situations where tradeoffs must be made
between more dollar sales of one product versus more dollar sales of another.
Generally speaking, when trying to increase sales, products that yield the
greatest amount of
contribution margin per dollar of sales should be emphasized.
