Contribution margin is a financial metric that measures the profitability of individual products, services, or business segments. It represents the amount of revenue left after subtracting variable costs directly associated with the production or delivery of those products or services.
How to calculate contribution margin
Contribution Margin = Revenue – Variable Costs
Variable costs include expenses such as direct materials, direct labor, and variable overhead costs.
Contribution margin is typically expressed as either a percentage or a dollar amount.
When expressed as a percentage, it is calculated by dividing the contribution margin by the revenue and multiplying by 100. This percentage represents the portion of revenue that contributes to covering fixed costs and generating profit.
For example, if a product has a contribution margin of $10,000 and generates $50,000 in revenue, the contribution margin percentage would be:
Contribution Margin Percentage = ($10,000 / $50,000) x 100 = 20%
This means that 20% of the revenue from that product is available to cover fixed costs and contribute to profits.
Alternatively, contribution margin can be expressed as a dollar amount, indicating the actual amount of revenue left after deducting variable costs. In the above example, the contribution margin would be $10,000.
How to use contribution margin and what does it tell you
Contribution margin is an important metric for making marketing decisions as it helps you assess the profitability and financial viability of your products or services. By analyzing the contribution margin, you can determine the impact of different pricing strategies, promotional activities, or changes in product mix on the overall profitability of the business.
A higher contribution margin indicates a larger portion of revenue is available to cover fixed costs and contribute to profits. This can guide you in identifying high-margin products or services that are driving profitability and focus your efforts on promoting or expanding those offerings.
Furthermore, contribution margin analysis can help you identify low-margin products or services that may require adjustments in pricing, cost control, or marketing strategies. By understanding the contribution margin of different products or services, you can allocate resources effectively, optimize marketing campaigns, and make informed decisions to enhance overall profitability.