How to Calculate the Contribution Margin Ratio
Contribution margin refers to the margin by which a company’s sales revenue exceeds its variable cost. It can be either calculated per unit or determined as a total percentage. The ratio will indicate the percentage of sales left to take care of fixed costs and profits.
It is presented in the financial statement ratio analysis spreadsheet, and helps managers in the decision making process by providing the relationship between costs, sales and over all income. As the ratio depicts how the costs and profits are affected with the change in volume, managers are in a better position to decide whether a particular product is worth producing, whether changes are to be made to the final pricing, or whether the production methods should be altered.
Instructions
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1
The general formula to calculate contribution margin ratio is:
Contribution Margin (CM) / Sales, where CM is computed by Total Sales – Variable Cost. Variable cost can be either direct (which is directly used in the making of the product such as material), or indirect such as variable overheads.
For simplicity, let’s suppose the revenue or total sales of the company were $60,000, while the variable cost was $40,000.
The total contribution margin therefore will be 20,000 (60,000-40,000). In order to compute the contribution margin ratio, simply divide this value by the total sales; 20,000/60,000 x 100 = 33.3 % -
2
For instance, if the company incurred fixed costs in the region of 20,000 then subtracting this amount from the total contribution ratio will tell us that the company is at the break even point.
- Revenue 60,000
- Variable Expense 40,000
- Contribution margin 20,000
- Fixed Cost (20,000)
- Net Profit/Loss 0
One can further determine the unit contribution margin, if the unit price is provided. For instance, if a company makes 200 items, and sells them at $ 5 each, and incurs Direct Labour cost and Direct Material cost at $ 2 and $ 1 respectively, then the total contribution margin will be as follows:
(200x5) – (200x2 + 200x1) = 1000- 600= $ 400
Hence the unit contribution margin will be 5-2-1= $ 2
