A business’s contribution margin—also called the gross margin—is the money left over from sales after paying all variable expenses associated with producing a product. Subtracting fixed expenses, such as rent, equipment leases, and salaries from your contribution margin yields your net income, or profit.
Calculating a contribution margin
Your contribution margin is calculated by taking:
Product revenue generated – product variable costs/product revenue generated
So, if a company generated $250,000 from product sales that had associated variable costs of $100,000, the contribution margin would be:
250,000 – 100,000/250,000 = .60 or 60%
What is a good contribution margin?
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.
However, it’s more likely that the contribution margin ratio is well below 100%, and probably below 50%.
The contribution margin ratio can be used as a measure of a company’s profitability as well as a measure of how profitable a particular product line is. Evaluating the contribution margin ratio for a certain brand or product can help determine if it makes sense for the company to continue selling it at its current price.
If the contribution margin is extremely low, it likely isn't profitable enough to keep producing. Eliminating low contribution margin products can positively impact a company’s overall contribution margin.
Improving contribution margin
In order to improve a company’s contribution margin, you either need to reduce variable costs, such as raw material and shipping expenses, or increase the price of your products and services.
The lower your contribution margin, the more difficult it is for your business to cover your fixed costs. Cutting those costs, such as by relocating into less expensive space or eliminating non-essential positions, is one way to improve your financial position.
Contribution Margin FAQ
What is the meaning of contribution margin?
What are the examples of contribution margin?
- Sales of a product or service
- Cost savings from reducing overhead expenses
- Increase in volume or prices of goods or services
- Reduction in cost of goods sold
- Increase in efficiency of production processes
- Increase in sales of higher margin products
- Decrease in selling, general and administrative expenses
- Increase in sales of lower margin products
- Increase in pricing of goods or services
- Increase in market share