Contribution Margin Explained

It can be defined as the marginal profit earned by a firm or a business at the sale of each unit of the product. Contribution margin is used to measure the profitability of a product for a company and helps in deciding the future of the product. It is very easy to calculate contribution margin for a business as you need to subtract the variable cost per unit of product from the sale price of the product.

Contribution Margin = Sales Price – Variable price per unit

By knowing the profitability of a certain product a company may decide about the future production, marketing and sale strategy of that specific product. As we know that the variable cost of the product fluctuates with the size of production where as the fixed cost remains the same for any size of production. With the help of contribution you can also calculate a number of other financial figures such as operating income or operating profit as under:-

Operating Income or Loss = Contribution Margin – Fixed Costs

From the above mentioned equation you can calculate operating income that can be further used to calculate net profit that is the profit of a company before subtracting the expenses from it. Another important figure that can be calculated from contribution margin is that of contribution margin ratio which is calculated as under:-

Percentage of Contribution Margin = (Total Revenue- Variable Cost)/Total Revenue x 100

One thing must be kept in mind that in order to calculate contribution margin we need to know fixed and variable costs associated with the products.

Other Related Accounting Articles:

• Contribution Margin Ratio (CM Ratio)
• Net Profit Ratio (NP Ratio)
• Gross Profit Ratio (GP Ratio)
• Price to Earnings Ratio
• Price to Sale Ratio
• Gross Profit Ratio
• Overhead Ratio
• Net Profit Ratio
• Key Ratio
• Working Ratio