# Contribution Margin vs Gross Margin

Updated on April 18, 2024
Article byPritha Banerjee
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

The key difference between Contribution Margin and Gross margin is that Contribution margin is the difference between total sales by the company and its total variable cost, which helps measure how efficiently the company is handling its production and maintaining the low levels of the variable costs. In contrast, the Gross margin formula is used to know the company’s financial health and performance and is calculated by dividing the gross profit by its net sales.

## Differences Between Contribution and Gross Margin

Gross Margin indicates the profitability of the company, whereas contribution indicates profit contributed by each of the products of the company.

### What is Gross Margin?

• Gross margin is revenue minus the divided by the revenue. The cost of goods sold includes only the production costs, i.e., the fixed costs and the variable .
• Cost of goods sold is very specific as it includes only those expenses which are directly associated with the production of the good. It doesn’t include other like wages, rent.
• Gross margin is important as it measures the preliminary profitability of a company before subtracting the and subsequently calculating the operating income and net income.

We can illustrate gross margin using the below income statement:

The income statement of company ABC for the year ended December 2017

Therefore gross profit/gross margin is the first step to analyze the initial amount of sales before we deduct the other operating expenses like advertising and like taxes and interest on loans. In order to avoid losses, the Gross Margin needs to be high in order to cover the .

For eg:
Source: Contribution Margin vs Gross Margin (wallstreetmojo.com)

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### What is the Contribution Margin?

• is the product sale price minus the variable cost per product. Contribution Margin takes into account the individual profit of each product. Only variable costs are used to and not fixed costs, which are associated with production.
• Contribution Margin also helps analyze the breakeven point of sales, i.e., the point at which we can generate profits. The greater the contribution margin, the more quickly we can generate profits as more sales of each product go towards the coverage of .
• Fixed costs remain the same irrespective of the sales numbers of the company. For example, rent, fixed salaries of the employees, and taxes. Variable costs, however, are directly proportional to sales. It increases when sales rise and vice versa. Examples of variable costs are , which are directly linked to sales volume.

### Example

A company had Net Sales of \$450,000 during the year 2016. The goods inventory was of the same quantity at the beginning and the end of the year. Its Cost of Goods Sold consisted of \$130,000 in variable costs and \$200,000 in fixed costs. Its selling and administrative expenses were \$30,000 for variables and \$150,000 for fixed expenses.

• The company’s Gross Margin is: Net Sales of \$450,000 minus its Cost of Goods Sold of \$330,000 (COGS: \$130,000 + \$200,000) for a Gross Profit of \$120,000 (\$450,000 – \$330,000). The is the Gross Profit of \$120,000 divided by \$450,000 (net sales), or 26.66%.
• The company’s Contribution Margin is: Net Sales of \$450,000 minus the variable product costs of \$130,000 and the variable expenses of \$30,000 for a Contribution Margin of (\$450,000-130,000-30,000) = \$290,000. The Contribution Margin Ratio is 64.4% (\$290,000 divided by \$450,000).