When you run a small business, it’s important to always know your break-even point -- the amount of sales needed to pay for all of your costs in a period. Below break-even, you generate a loss; above it, you turn a profit. The contribution margin ratio reveals the percentage of sales that applies to your fixed costs after covering variable costs. When you know your contribution margin ratio, you can figure your break-even point in dollars and units with a couple of straightforward calculations. Show
About the Contribution Margin Ratio
Fixed and Variable Costs
Contribution Margin Ratio Calculation Example
Dollar Break-Even Point
Unit Break-Even Point
A business' sales revenue less its variable costs What is Contribution Margin?Contribution margin is a business’ sales revenue less its variable costs. The resulting contribution dollars can be used to cover fixed costs (such as rent), and once those are covered, any excess is considered earnings. Contribution margin (presented as a % or in absolute dollars) can be presented as the total amount, amount for each product line, amount per unit product, or as a ratio or percentage of net sales. Formula for Contribution MarginIn terms of computing the amount: Contribution Margin = Net Sales Revenue – Variable Costs OR Contribution Margin = Fixed Costs + Net Income To determine the ratio: Contribution Margin Ratio = (Net Sales Revenue -Variable Costs ) / (Sales Revenue) Sample Calculation of Contribution MarginA mobile phone manufacturer has sold 50,000 units of its latest product offering in the first half of the fiscal year. The selling price per unit is $100, incurring variable manufacturing costs of $30 and variable selling/administrative expenses of $10. As a result, the contribution margin for each product sold is $60 or in totality for all units is $3M, having a contribution margin ratio of .60 or 60%. What are Variable Costs?Variable costs are direct and indirect expenses incurred by a business from producing and selling goods or services. These costs vary depending on the volume of units produced or services rendered. Variable costs rise as production increases and falls as the volume of output decreases. Also, it is important to note that a high proportion of variable costs relative to fixed costs, typically means that a business can operate with a relatively low contribution margin. In contrast, high fixed costs relative to variable costs tend to require a business to generate a high contribution margin in order to sustain successful operations. Examples of variable costs are:
What are Fixed Costs?Fixed costs are expenses incurred that do not fluctuate when there are changes in the production volume or services produced. These are costs that are independent of the business operations and which cannot be avoided. In determining the price and level of production, fixed costs are used in break-even analysis to ensure profitability. Examples of fixed costs are:
How Important is Contribution Margin in Business?When a company is deciding on the price of selling a product, contribution margin is frequently used as a reference for analysis. Fixed costs are usually large – therefore, the contribution margin must be high to cover the costs of operating a business. A low or negative contribution margin indicates a product line or business may not be that profitable, so it is not wise to continue making the product at its current sales price level unless it is a very high volume product. It is important to assess the contribution margin for breakeven or target income analysis. The target number of units that need to be sold in order for the business to break even is determined by dividing the fixed costs by the contribution margin per unit. To resolve bottlenecks, contribution margin can be used to decide which products offered by the business are more profitable and, therefore, more advantageous to produce, given limited resources. Preference is given to products that provide a high contribution margin. Additional ResourcesThank you for reading CFI’s guide to Contribution Margin. In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:
What does 100% contribution margin mean?The closer a contribution margin percent, or ratio, is to 100%, the better. The higher the ratio, the more money is available to cover the business's overhead expenses, or fixed costs.
How do you find variable cost from contribution margin ratio?How to Calculate Contribution Margin. Net Sales – Variable Costs = Contribution Margin.. (Product Revenue – Product Variable Costs) / Units Sold = Contribution Margin Per Unit.. Contribution Margin Per Unit / Sales Price Per Unit = Contribution Margin Ratio.. Is variable cost ratio the same as contribution margin ratio?The contribution margin is equal to 1 – the variable cost ratio. That means in the examples above, the contribution margin ratio would be either 90% or 95%.
What is variable cost contribution margin?What is the Variable Contribution Margin? Variable contribution margin is the margin that results when variable production costs are subtracted from revenue. It is most useful for making incremental pricing decisions where an entity must cover its variable costs, though not necessarily all of its fixed costs.
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