What is Contribution Margin?
Ahead of discussing how to calculate contribution margin ratio, let us define what contribution margin is. Contribution margin represents the incremental money generated for each unit sold after deducting the variable portion of the firm’s costs.It is the foundation for break-even analysis used in the overall cost and sales price planning for products.
The contribution margin helps to separate out the fixed cost and profit components coming from product sales and can be used to determine the selling price range of a product, their profit levels and structure sales commissions paid to sales team members, distributors or commission agents.
What is a Margin Contribution Ratio?
The contribution margin ratio is the difference between a company’s sales and variable expenses divided by the total sales, expressed as a percentage.
A contribution margin ratio shows how much money is available to pay the fixed costs such as rent and utilities. Even when production or output is zero they must be paid.
If a product’s contribution margin is negative, the company is losing money and it should either drop the product or increase prices and when its positive it means that the product is worth keeping.
Formula to Calculate Contribution Margin Ratio.
Total revenue is the full amount of total sales of goods and services.
While variable costs are the direct costs that a company incurs when producing goods or services.
Example:
Suppose a company’s total revenue in 2019 was $ 570,000 and the variable cost of the same year was worth $ 200,000. Determine the company’s contribution margin ratio for 2019.
Thus, the CM ratio of the company in 2019 was 64.9%.
Example 2:
A company has revenues of $100 million, the cost of goods sold is $60 million, marketing is $10million, product delivery fees are $5 million, and fixed costs are $12 million. Calculate the contribution margin ratio.
First we will need to find the contribution margin.
Hence, the contribution margin is 25 million.
Secondly, we find the contribution margin ratio.
Therefore, the contribution margin ratio is 25%.
