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What is the difference between gross margin and contribution margin?

Author:
Harold Averkamp, CPA, MBA

Definition of Gross Margin

Some use the term gross margin to mean the same as gross profit, which is: net sales minus the cost of goods sold. Others use the term gross margin to indicate the gross profit as a percentage of net sales.

The cost of goods sold will consist of both fixed and variable product costs. However, selling, general and administrative expenses (SG&A) are not part of the cost of goods sold.

Definition of Contribution Margin

Contribution margin is defined as net sales minus both the variable product costs and the variable SG&A expenses. The contribution margin can also be expressed as a percentage of net sales. In that case it is often described as the contribution margin ratio.

Information for Examples

Let’s assume that a company had the following amounts during the past year:

  • Net sales of $600,000
  • Cost of goods sold of $320,000 ($120,000 variable + $200,000 of fixed)
  • Inventories did not increase or decrease
  • SG&A expenses of $190,000 ($40,000 variable + $150,000 fixed)

Example of Gross Margin

The company’s gross margin is: net sales of $600,000 minus the cost of goods sold of $320,000 = $280,000. The gross margin or gross profit percentage is: gross profit of $280,000 divided by net sales of $600,000 = 46.7%.

Example of Contribution Margin

The company’s contribution margin is: net sales of $600,000 minus the variable product costs of $120,000 and the variable expenses of $40,000 = $440,000. The contribution margin ratio is 73.3% ($440,000 divided by $600,000).

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About the Author

Harold Averkamp

For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com.

Learn More About Harold

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