Contribution Margin Definition – Formula, Example & Importance

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Contribution Margin Definition Formula and Example

Contribution Margin Definition – In product cost analysis, unit revenue minus variable cost per unit; the sum of money available to contribute to fixed costs.

In simple words it is the amount of profits that are left after providing for the variable costs or direct costs. Variable costs are those costs which vary  with the output. If the output increases, variable costs also increases and vice versa. Contribution margin is the difference of Sales and total Variable costs.

It is also known as contribution margin per unit and Contribution Margin ratio. The formula for calculating them slightly differs from each other.

Formula

Contribution Margin  = Sales – Total Variable Costs

Contribution Margin per unit = Sales per unit – variable cost per unit

Or

= Total contribution margin/ total units sold

 

Example of Contribution Margin

Let’s discuss an example to understand contribution  margin definition more clearly. Footwear Inc is a shoe manufacturing firm. The  sales price of X brand of shoe of the company is Rs 400, variable cost is Rs. 150 and fixed costs per annum are Rs. 2,00,000. This year company is successful in selling 1,00,000 units. Calculate the contribution margin of the company.

Contribution margin /u = 400 – 150

= 250

Total sales = 400 × 1,00,000

= 4,00,00,000

Variable cost = 150 × 1,00,000

= 1,50,00,000

Contribution margin = 4,00,00,000 – 1,50,00,000

= 2,50,00,000

Related Financial Terms of Contribution

Importance of Contribution Margin for Business

Contribution margin act as a input for the calculation of the break even point. Break even point is a point where company makes zero profit. It is very important for the company to know its break even point so that it can estimates in advance the number of units to be produce and sell in order to earn profit.

Calculating contribution margin of the business is very helpful for managers in order to examine how the expenditure done on fixed cost results in changing the amount of direct costs involved. In addition to this, it is also helpful in making forecasts related to sales, direct costs and fixed costs.

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