Definition of Contribution Margin Ratio
The contribution margin ratio is the percentage of sales revenues, service revenues, or selling price remaining after subtracting all of the variable costs and variable expenses.
Expressed another way, the contribution margin ratio is the percentage of revenues that is available to cover a company's fixed costs, fixed expenses, and profit.
Note that the contribution margin ratio is not the same as the gross margin ratio or gross profit percentage. Further, the contribution margin ratio cannot be computed from the amounts appearing on a company's external income statement.
Example of Contribution Margin Ratio
Assume that a company manufactures and sells a single product and has the following information:
- Selling price per unit is $20
- Fixed manufacturing costs per month is $18,000
- Variable manufacturing costs per unit is $4
- Fixed SG&A expenses per month is $12,000
- Variable SG&A expenses per unit is $2
- Fixed interest expense per month is $1,000
Using the above information 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). Therefore, 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 70% of the selling price) is available to cover the company's $31,000 of monthly fixed costs and fixed expenses ($18,000 + $12,000 + $1,000). Once the $31,000 has been covered, 70% of the revenues will flow to the company's net income.