Definition of Contribution Margin
In accounting, contribution margin is defined as: revenues minus variable expenses. The contribution margin can be expressed as an amount and/or as a ratio or percent of revenues.
The contribution margin tells us how much of the revenues will be available (after the variable expenses are covered) for the fixed expenses and net income.
The contribution margin amount or ratio (ratio) can be presented for:
- The company as a whole
- A product line
- An individual unit of a product
Example of Contribution Margin
Let's assume that a manufacturer has only one product and 80,000 units were manufactured and sold during a recent year. The selling price was $10 per unit. The variable expenses were $4 per unit (consisting of manufacturing costs of $3 per unit and variable SG&A expenses of $1 per unit). The company's fixed expenses were $390,000 (consisting of fixed manufacturing costs of $300,000 and fixed SG&A expenses of $90,000).
The amount of the company's contribution margin was $480,000 calculated using the following amounts:
- Revenues of $800,000 (80,000 units X $10 per unit)
- Variable expenses of $320,000 (80,000 X $4 per unit)
The contribution margin ratio for the company was 60% (contribution margin of $480,000 divided by revenues of $800,000).
The contribution per unit of the company's only product was $6 consisting of revenues of $10 minus the variable expenses of $4. The contribution margin ratio for the product was also 60% (contribution margin of $6 divided by the selling price of $10).
The contribution margin is a key component in computing a company's break-even point.