What is Contribution Margin?
Contribution margin is the amount of sales revenue left after covering variable costs — the money available to pay fixed costs and generate profit. It's a core tool for pricing, product-mix, and break-even decisions.
Contribution margin per unit equals selling price minus variable cost per unit; the contribution margin ratio is that amount divided by selling price, showing what portion of every sales dollar contributes to fixed costs and profit.
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Step-by-step worked examples
A product sells for $50 with a variable cost of $30 per unit. Find the contribution margin per unit and the CM ratio.
CM per unit = 50 − 30 = $20 CM ratio = 20 / 50 = 40%
Using the product above, the company sells 1,200 units. Find total contribution margin.
Total CM = CM per unit × units sold Total CM = 20 × 1,200 = $24,000
A firm reports sales of $200,000 and variable costs of $120,000. Find total contribution margin and the CM ratio.
Total CM = 200,000 − 120,000 = $80,000 CM ratio = 80,000 / 200,000 = 40%
Flashcards
Quick quiz
Q1.Contribution margin equals:
Q2.A product sells for $80 with a variable cost of $50. Its contribution margin per unit is:
Q3.The contribution margin ratio is calculated as:
Q4.If the CM ratio is 40% and sales are $500,000, total contribution margin is:
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Common mistakes
Confusing contribution margin with gross profit. — Correct: CM subtracts only variable costs; gross profit subtracts COGS, which can include fixed manufacturing costs.
Ignoring the CM ratio when comparing products. — Correct: CM ratio lets you compare profitability per sales dollar across products with different prices.
Treating fixed costs as part of the CM formula. — Correct: Fixed costs are covered by contribution margin — they are not subtracted in the CM calculation itself.
Assuming a higher price always means a higher CM ratio. — Correct: CM ratio depends on both price and variable cost — a cheaper product with lower variable cost can have a higher CM ratio.
FAQ
What is contribution margin?
Contribution margin is sales revenue minus variable costs — the amount available to cover fixed costs and generate profit.
What is the contribution margin formula?
CM per unit = Selling Price − Variable Cost per unit. CM ratio = CM per unit / Selling Price.
What are examples of contribution margin analysis?
Computing CM per unit for a $50 product with $30 variable cost ($20 CM, 40% ratio), or total CM from $200,000 sales and $120,000 variable costs ($80,000).
How do you calculate the contribution margin ratio?
Divide contribution margin by sales revenue: CM ratio = Contribution Margin / Sales, expressed as a percentage.