The contribution margin ratio is the percentage of sales, service revenues or selling price that remains after all variable costs and variable expenses have been covered. In other words, the contribution margin ratio is the percentage of revenues that is available to cover a company's fixed costs, fixed expenses, and profit. (The contribution margin ratio is different from the gross margin ratio or gross profit percentage and cannot be computed directly from the reported amounts on the company's external income statement.)

To illustrate the contribution margin ratio, we will assume that a company manufactures and sells a single product and has the following facts:

  • selling price per unit of $20

  • fixed manufacturing costs per month of $18,000

  • variable manufacturing costs per unit of $4

  • fixed SG&A expenses per month of $12,000

  • variable SG&A expenses per unit of $2

  • fixed interest expense per month of $1,000
In this example the contribution margin per unit is $14 (the selling price of $20 minus the variable manufacturing costs of $4 and variable SG&A expenses of $2). Hence, the contribution margin ratio is 70% (the contribution margin per unit of $14 divided by the selling price of $20). This contribution margin ratio tells us that 70% of the sales, revenues, or selling price is available to cover the $31,000 of monthly fixed costs and fixed expenses. Once the $31,000 has been covered, 70% of the revenues will flow to the company's net income.