What Is Contribution Margin?
Contribution margin is a business accounting term that measures the difference between sales revenue and the variable costs to produce or sell a product. It shows the amount of profitability a company would achieve once it covers its fixed costs, i.e., its breakeven point.
A company's fixed costs remain basically the same whether it makes or sells one unit or thousands. The most common fixed costs are rent and the costs associated with keeping a store or factory open. For example, a grocery store's fixed costs would include the building, keeping the lights and refrigerators on, and so forth.
A company's variable costs change depending on how many products or sales it makes. For example, a computer manufacturer's costs for labour, components, shipping, and the like would rise the more computers it sells.
How Is A Contribution Margin Calculated?
The contribution margin is calculated simply as such: Contribution margin = Sales revenue – variable costs
To express it as a ratio, simply divide that figure by total sales, as such: Contribution margin ratio = Sales revenue – variable costs/Sales revenue
Companies can calculate these figures for the entire company or division or on a per unit basis. For example, if a company sells a computer for US$500 and the variable cost to produce one is US$300, the contribution margin would be $200. That amount of money would be used to contribute—hence the name—to the company's fixed costs and, ultimately, profitability.
Generally speaking, companies in labour-intensive industries, such as apparel manufacturers, would have relatively low contribution ratios. They have to hire more workers and buy more material the more clothes they sell. As a result, their profitability doesn't necessarily rise along with sales.
By contrast, capital-intensive, industrial companies with high fixed costs, such as automobile manufacturers, would have high contribution margins. Their profits would rise once their sales exceed the break-even point on fixed costs. It is therefore preferable to have high contribution margins, assuming of course that sales go up, because profitability would rise with revenue.
Contribution margin is a business accounting term that measures the difference between sales revenue and the variable costs to produce or sell a product. It shows the amount of profits a company would achieve once it covers its fixed costs, i.e., its breakeven point.
FXCM Research Team
FXCM Research Team consists of a number of FXCM's Market and Product Specialists.
Articles published by FXCM Research Team generally have numerous contributors and aim to provide general Educational and Informative content on Market News and Products.
Any opinions, news, research, analyses, prices, other information, or links to third-party sites contained on this website are provided on an "as-is" basis, as general market commentary and do not constitute investment advice. The market commentary has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and it is therefore not subject to any prohibition on dealing ahead of dissemination. Although this commentary is not produced by an independent source, FXCM takes all sufficient steps to eliminate or prevent any conflicts of interests arising out of the production and dissemination of this communication. The employees of FXCM commit to acting in the clients' best interests and represent their views without misleading, deceiving, or otherwise impairing the clients' ability to make informed investment decisions. For more information about the FXCM's internal organizational and administrative arrangements for the prevention of conflicts, please refer to the Firms' Managing Conflicts Policy. Please ensure that you read and understand our Full Disclaimer and Liability provision concerning the foregoing Information, which can be accessed here.