To perform a more detailed analysis on either a quarterly or year-over-year (YoY) basis – or comparisons to comparable companies in the same industry – the CM can be divided by revenue to get to the CM ratio. The distinction pertains to the concept of scalability, as companies with higher variable costs tend to bring in fewer profits since the direct costs increase (and can offset) the growth in revenue. Fixed Costs: e.g. Utilities, Rent, Insurance, EquipmentĪll else being equal, the greater the CM of each product, the more profitable the company is going to be, with more cash available to meet other expenses.Purchase of Inventory/Materials, Direct Labor, Shipping Costs Just as a quick review, a company’s variable costs are directly associated with revenue and fluctuate based on production volume, whereas fixed costs remain unchanged regardless of production volume. Contribution Margin = Revenue – Variable Costs.The calculation of the metric is relatively straightforward, as the formula consists of revenue minus variable costs. Given how the CM examines the product-level breakdown of each dollar that comes in and how it contributes to generating profit, the break-even point cannot be calculated without determining the CM.įor companies seeking to obtain a sustainable long-term competitive advantage, it’s important to focus on identifying the products with the highest CMs in order to maximize potential profits. Discontinued → The product offering could be discontinued if there is insufficient customer demand after a potential price increase.Īdditionally, the assessment of the CM can help determine the optimal pricing by assessing the impact each change would have on revenue and profitability levels.Increased → The pricing of the product line could be raised to contribute towards more profitability, as the current profit margins are unsustainable (or).In such cases, the price of the product would either be: If the margin is too low, the current price point may need to be reconsidered. In particular, the use-case of the metric tends to be most applicable for setting prices appropriately. Instead of looking at the profitability of a company on an overall basis with all products grouped together, the CM enables margin analysis on an individual product line basis.
how much revenue exceeds the associated variable costs. The contribution margin is the profits generated after variable costs have been deducted – i.e. While there are various profitability metrics – ranging from the gross margin down to the net profit margin – the contribution margin (CM) metric stands out for the analysis of a specific product/service. Contribution Margin Calculation Example.Contribution Margin Calculator – Excel Template.
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