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What is a Contribution Margin?
The contribution margin is the excess amount remaining, after the variable costs have been deducted, e.g. the amount that contributes to cover the company’s fixed costs and generate profit.
Example: how to calculate a contribution margin
A company sells Product A for $ 150.00, and have variable costs in relation to purchasing, packaging and freight. The purchase price is $ 60.00, packaging $ 5.00 and freight $ 10.00. The contribution margin is therefore calculated as follows:
Sales price = 150 - purchase price: 60 - packaging: 5 - freight: 10. Margin = 75
$ 75.00 are now left to cover the company's fixed costs - such as rent, payroll, etc. If this is not enough to cover the fixed costs, the company will suffer a deficit. However, there's a surplus (profit) if the contribution margin exceeds the company’s fixed costs.
Using the contribution margin in comparison
Comparing contribution margins across different industries cannot be recommended, because it can vary a lot between the different types of business involved.
Some companies may have a high contribution margin, but also many fixed costs - whereas the contribution margin may be low in other companies with fewer fixed costs. The company's contribution margin will always appear in the income statement.
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