Contribution Margin

Contribution margin (CM) is the amount by which sales revenue exceeds variable costs. It is the net amount that sales ‘contribute’ towards periodic fixed costs and profits. It is expressed either as total contribution margin, contribution margin per unit or contribution margin ratio.

Variable costs are costs which vary directly with sales. For example, if sales double, variable costs double too, and vice versa. Variable cost may be direct as well as indirect. Direct variable costs include direct material cost and direct labor cost. Indirect variable costs include certain variable overheads.

Contribution margin is an important input in calculation of breakeven point, i.e. the sales level (in units and/or dollars) at which a company makes zero profit. Breakeven point (in units) equals total fixed costs divided by contribution margin per unit and breakeven point (in dollars) equals total fixed costs divided by contribution margin ratio.

Formula

Total contribution margin (CM) is calculated by subtracting total variable costs TVC from total sales S.

$$ \text{CM}\ =\ \text{S}\ -\ \text{TVC} $$

Contribution margin per unit equals sales price per unit P minus variable costs per unit V or it can be calculated by dividing total contribution margin CM by total units sold Q.

$$ \text{CM per Unit}\ =\ \frac{\text{CM}}{\text{Q}}=\text{P}\ -\ \text{V} $$

Contribution margin ratio equals contribution margin expressed as a percentage of sales.

$$ \text{CM Ratio}\ =\frac{\text{CM per Unit}}{\text{P}}=\frac{\text{CM}}{\text{S}} $$

Weighted average contribution margin per unit equals the sum of contribution margins of all products divided by total units. Weighted average contribution margin ratio equals the sum of contribution margins of all products divided by total sales.

Example

Jump, Inc. is a sports footwear startup which currently sells just one shoe brand, A. The sales price is $80, variable costs per unit is $50 and fixed costs are $2,400,000 per annum (25% of the which are manufacturing overhead costs) . During financial year 2015, the company sold 200,000 units. Calculate the company’s contribution margin for the period and calculate its breakeven point in both units and dollars.

Solution

Contribution margin per unit = Sales price – Variable cost per unit = $80 – $50 = $30

Total contribution margin = Total sales – Total variable costs = Units sold × Sales price – Units sold × Variable cost per unit = Units sold × (Sales price – Variable cost per unit) = $80 × 200,000 - $50 × 200,000 = 200,000 × ($80 - $50) = $6,000,000

Total contribution margin can also be calculated as follows:

Total contribution margin = Contribution margin per unit × Unit sales = $30 × 200,000 = $6,000,000

Breakeven point in units = Fixed costs/Contribution margin per unit = $2,400,000/$30 = 80,000 units

Breakeven point in dollars = Breakeven point in units × Sales price = 80,000 × $80 = $6,400,000

by Irfanullah Jan, ACCA and last modified on

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