what is contribution margin

Contribution margin is a financial metric that measures how much revenue is available after deducting variable costs like raw materials and shipping expenses from sales revenue. It is the amount of sales revenue that remains after a company pays for its variable costs and is used to cover its fixed costs. The contribution margin can be stated on a gross or per-unit basis and is calculated as the selling price per unit minus the variable cost per unit. It is different from gross margin in that it seeks to separate out variable costs from fixed costs on the basis of economic analysis of the nature of the expense. The contribution margin helps to separate out the fixed cost and profit components coming from product sales and can be used to determine the selling price range of a product, the profit levels that can be expected from the sales, and structure sales commissions paid to sales team members, distributors, or commission agents. The contribution margin ratio is the percentage of contribution over total revenue and can be calculated from the unit contribution over unit price or total contribution over total revenue. The contribution margin is an excellent tool for managers to help determine whether to keep or drop certain aspects of the business.