Definition
Contribution margin is sales revenue minus variable costs, expressed in total, per unit or as a ratio of sales. It is the amount each sale contributes first toward covering fixed costs and then toward profit, which makes it the central number in break-even analysis, pricing decisions and choosing which products to push.
How it works
Variable costs are those that rise with each unit sold: materials, packaging, shipping, sales commissions, card fees. Subtract them from the price and what is left is the unit contribution. Divide it by the price and you get the contribution margin ratio, the share of every sale that is available for fixed costs and profit.
Contribution margin is not the same as gross margin. Gross margin subtracts cost of sales, which under absorption costing includes fixed production overhead, and leaves out variable selling costs. Contribution margin separates costs by behaviour instead, which is what you need to predict how profit moves with volume.
When a resource is scarce, such as machine hours, rank products by contribution per unit of that resource, not per unit sold. Ledgeriano classifies each account as fixed, variable or mixed and builds contribution-format statements, CVP analysis and limiting-factor decisions from your books; see the management accounting guide.
Formula
Contribution margin = Sales - Variable costs
Unit contribution = Price - Variable cost per unit
CM ratio = Contribution margin ÷ Sales
Example: a contribution format income statement
A product sells 2,400 units at 50 with a variable cost of 30 per unit. Fixed costs are 30,000.
| Line | Total | Per unit | % of sales |
|---|---|---|---|
| Sales | 120,000 | 50 | 100% |
| Variable costs | 72,000 | 30 | 60% |
| Contribution margin | 48,000 | 20 | 40% |
| Fixed costs | 30,000 | ||
| Operating profit | 18,000 | 15% |