Contribution Margin

Related Video

Target Profit

Make more money now! Try our JOB search.

Share This:

Related Video

Break Even Point

Make more money now! Try our JOB search.

Share This:

Contribution margin is one of the most important concepts in managerial accounting. It is used extensively in planning and decision making because it is much easier to use than absorption costing, especially as variables change in the planning process.

Make more money now! Try our JOB search.

Contribution margin can be defined in a number of different ways. Contribution margin per unit is price less variable cost per unit. Total contribution margin is sales less total variable costs. These are the two definitions you will see most often for contribution margin. I like to define contribution margin as the amount from each unit that contributes to fixed cost and profit.

Let’s look back at the contribution margin income statement:

NoCMIS1tice that contribution margin less fixed cost is profit. In order to make a profit, total contribution margin must be greater than fixed costs. Once all of our fixed costs are paid for, any additional sales generate profit.

But how much profit? Each unit would generate profit equal to the contribution margin for that unit. If the contribution margin per unit is $10, then each additional unit sold would provide an additional $10 of profit.

Contribution margin is most often expressed as a monetary unit, but we can also express it as a percentage of price. This is called the contribution margin ratio. The contribution margin ratio tells us the percentage of each sales dollar that becomes contribution margin

Contribution margin ratio = contribution margin per unit / price


Contribution margin ratio = total contribution margin / sales

We can also look at variable cost as a ratio. The variable cost ratio tells us the percentage of each sales dollar that would go toward variable cost.

Variable cost ratio = variable cost per unit / price


Variable cost ratio = total variable cost / sales

As long as price and variable cost remain the same, these ratios will remain the same. It does not matter if the company sells 10 units or 1 million units, the percentage of each sale that becomes contribution margin or does to cover variable costs is the same.

Let’s look at an example to illustrate how to calculate contribution margin and these ratios.

Example #1

Hangout Limited, LLC sells one product priced at $40 per unit. The variable costs (direct materials, direct labor, variable overhead and variable selling) is $25 per unit. Calculate the contribution margin per unit, the contribution margin ratio and the variable cost ratio.

We know that contribution margin is price less variable cost. Therefore, contribution margin is:

$40 – $25 = $15

That means that for every unit we sell, $15 will go to cover fixed cost and profit. Once the fixed costs are paid, $15 per unit becomes profit.

Now calculate the ratios. We’ll start with the contribution margin ratio. Contribution margin ratio is contribution margin per unit divided by price per unit.

$15 / $40 = 37.5%

What does that mean? For every dollar of revenue the company brings in,  37.5% or 37.5 cents will become contribution margin. This also tells us that 37.5% of every sale is available to pay fixed costs or generate profit.

The variable cost ratio is variable cost per unit / price.

$25 / $40 = 62.5%

This tells us that for every unit sold, 62.5% will go to cover variable costs.

These ratios are important as we start to look at planning and decision making using contribution margin.

Related videos

Contribution Margin

Share This:

Related pages

formula to calculate gross salaryinterest receivable adjusting entrygraphing slope calculatoraccrued salaries and wagesaccounts receivable income statementsales profit ratioassets have debit balanceformula for double declining balance depreciationclosing entries definitionis walmart a merchandising companybeginning inventory equationdiscounting tablesphysical inventory counts must be donea favorable cost variance occurs whenaccounting for prepaid insurancenormal balance of expense accountaccrued revenue entryplantwide overhead rate formuladefine debit balanceaccounting for preferred stock dividendswashington state unemployment tax rategross paycheck amountcontra account to accounts receivableaccrued expenses journal entryhow to calculate ending inventory using average costformula for owners equitywhat is the difference between financial accounting and managerial accountingformula for simple interest loanaccounts receivable in income statementrepayment of premium bondscontribution to sales ratio formulasales mix exampleimpaired receivablespartial year depreciation double declining balancepreemptive rights of equity shareholdersreversing entries accountingretained earnings formula on balance sheetperpetual inventory vs periodic inventorygross accounts receivable formulavaluing bondsadvantages and disadvantages of periodic inventory systemretained earnings definition accountingwhen preparing a bank reconciliation outstanding checks should beis cogs an expenseadjusting entry in accountinghow to find total variable cost on a graphaccounting closing journal entriesinventory turnover calculator onlineactivity based overhead rate formulabond issuance price calculatorpresent value of an ordinary annuitydirect material in cost accountingpremium bond exampleshare based payments journal entriesvariable expenses examplesfactory overhead cost examplesannuity pv tablecogs formulacalculate the present value of an annuityfiguring payrollturnover formula accountingbank reconciliation checks outstandingrecording accrued interestpreparing closing entriesfinish line hourly payjournal entry for treasury stockwithholding tax accounting entrieswhy accumulated depreciation is creditdebit credit journal entry examplesis trial balance a financial statementhow much federal withholdinghow many is a gross of pencilswhat is a payroll expenseaccumulated depreciation buildingabsorption of overheadsis direct labor a variable cost