Contribution margin is one of the accounting concepts that are used to measure the profitability of a company or enterprise. It is an important metric for any business because it measures how much income it has left over after subtracting all its expenses from its revenues. It is the amount of money that a company has left after it pays for its variable costs. It is a measure of how much profit a company has made.
Contribution margin formulae
Contribution Margin = Revenue – Variable Cost
Or in other words:
Contribution Margin = Sales – Cost of Goods Sold
Gross Margin = Contribution Margin + Operating Expenses
There are two types of margins – profit margin and contribution margin. Profit margin is the difference between the cost of goods sold and the selling price. Contribution margin is the difference between the selling price and total costs, including cost of goods sold.
A company’s gross profit margin is calculated as a percentage by dividing its total profits by its total sales revenue. A company’s contribution margin, on the other hand, is calculated as a percentage by dividing its contribution to sales revenue by its total costs. The difference between these two margins lies in their calculation methods: Gross profit margins are calculated before deducting fixed costs, while contribution margins are calculated after deducting fixed costs.
Application example of Contribution Margin
Suppose Diana as a manager of Camera company XYZ working on the budget and trying to estimate how many Camera Model X need to be sell to make a profit. By using Contribution Margin Formulae, she can first determine the direct materials, overhead and direct labor cost, and then she will be able to estimate how many Camera Model X need to be created in order to cover the cost
