Contribution margin is a financial metric that represents the portion of a products sales revenue that is not consumed by variable costs and therefore contributes to covering a company's fixed costs and generating profits. It is calculated by subtracting the variable cost per unit from the selling price per unit. The contribution margin can be expressed on a gross or per-unit basis and is often used to analyze a company's profitability and make various business decisions.
Some key points about contribution margin include:
- It measures how profitable a product is to produce and how much additional revenue is generated by making each additional unit after the company has reached the breakeven point.
- The contribution margin ratio is the percentage of contribution over total revenue, which can be calculated from the unit contribution over unit price or total contribution over total revenue.
- Business owners, finance teams, and accountants use contribution margins to determine which products are profitable, set prices, and make decisions about product lines, sales structures, and more.
- A high contribution margin is desirable as it helps cover fixed costs and generate profits, while a low or negative contribution margin may indicate a product line or business is not profitable.
