Contribution Margin

What is the Contribution Margin?

The contribution margin is a measurement through which we understand how much a company’s net sales will contribute to the fixed expenses and the net profit after covering the variable expenses.  So, while calculating the contribution, we deduct the total variable expenses from the net sales.

Contribution Margin Formula

To calculate this ratio, all we need to look at are the net sales and the total variable expenses. Here’s the formula –

Contribution Margin = Net Sales – Total Variable Expenses

Contribution Margin

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

It can be expressed in another way as well.

Contribution Margin = Fixed ExpensesNet Income

In situations, where there’s no way we can know the net sales, we can use the above formula to find out the contribution.

Example

Good Company has net sales of $300,000. It has sold 50,000 units of its products. The variable cost of each unit is $2 per unit. Find out the contribution, contribution margin per unit, and contribution ratio.

In this example, if we would have been given the fixed expenses, we could also be able to find out the net profit of the firm.

Uses

You may ask why we need contribution. We need a contribution to find out the break-even pointBreak-even PointBreak-even analysis refers to the identifying of the point where the revenue of the company starts exceeding its total cost i.e., the point when the project or company under consideration will start generating the profits by the way of studying the relationship between the revenue of the company, its fixed cost, and the variable cost.read more.

We will look at how contribution becomes useful in finding out the break-even point.

Let’s say that a firm’s fixed expenses are $100,000. The variable cost of the firm is $30,000. We need to find out the break-even point.

By using the concept of contribution, we will find out the break-even point.

Contribution Margin = Net Sales – Variable Cost = Fixed Cost + Net Profit

Here, we can write –

Net Sales – Variable Cost = Fixed Cost + Net Profit

At the break-even point, the key assumption is that there will be no profit or no loss.

Then,

That means $130,000 of net sales, the firm would be able to reach the break-even point.

Contribution Margin Calculator

You can use the following Calculator

Net Sales
Total Variable Expenses
Contribution Margin Formula
 

Contribution Margin Formula = Net Sales Total Variable Expenses
0 0 = 0

Calculate Contribution Margin in Excel (with excel template)

You can easily calculate the ratio in the template provided.

Selling Price per unit

The contribution margin ratio per unit formula would be = (Selling price per unit – Variable cost per unit)

Example

The contribution would be = (Margin per Unit * Number of Units Sold)

Example 1.1

The contribution ratio would be = margin / Sales

Contribution Margin Ratio in Excel

You can download this template here – Contribution Margin Ratio Excel Template

Contribution Margin Video

 

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This has been a guide to the Contribution Margin and its meaning. Here we discuss the formula to calculate Contribution Margin along with practical examples and excel templates. You may also look at the following articles to enhance your financial skills.