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What is contribution margin?

In accounting contribution margin is defined as revenues minus variable expenses. In other words, the contribution margin reveals how much of a company's revenues will be contributing (after covering the variable expenses) to the company's fixed expenses and net income. The contribution margin can be presented as 1) the total amount for the company, 2) the amount for each product line, 3) the amount for a single unit of product, and 4) as a ratio or percentage of net sales.

The contribution margin of a manufacturer is the amount of net sales that is in excess of the variable manufacturing costs and the variable SG&A expenses. To illustrate, let's assume that a manufacturer has a single product and 80,000 units were produced and sold during a recent year. The selling price was $10 per unit, variable manufacturing costs were $3 per unit, and variable SG&A expenses were $1 per unit. The company's fixed manufacturing costs were $300,000 and its fixed SG&A expenses were $90,000. The company's contribution margin was $480,000 ($800,000 - $240,000 - $80,000). The contribution margin per unit was $6 ($10 - $3 - $1). The contribution margin ratio was 60% ($6/$10 or $480,000/$800,000).

The contribution margin is also a key component in computing a company's break-even point.