contribution margin

Fin

a way of showing how much individual products or services contribute to net profit.

EXAMPLE

Its calculation is straightforward:

Sales price – variable cost = contribution margin

Or, for providers of services:

Total revenue – total variable cost = contribution margin

For example, if the sales price of a good is $500 and variable cost is $350, the contribution margin is $150, or 30% of sales. This means that 30 cents of every sales dollar remain to contribute to fixed costs and to profit, after the costs directly related to the sales are subtracted.

     Contribution margin is especially useful to a company comparing different products or services. For example:

     Obviously, Product C has the highest contribution percentage, even though Product A generates more total profit. The analysis suggests that the company might do well to aim to achieve a sales mix with a higher proportion of Product C. It further suggests that prices for Products A and B may be too low, or that their cost structures need attention. Notably, none of this information appears on a standard income statement.

     Contribution margin can be tracked over a long period of time, using data from several years of income statements. It can also be invaluable in calculating volume discounts for preferred customers, and break-even sales or volume levels.