The contribution margin, sometimes used as a ratio, is the difference between a company's total sales revenue and variable costs. In other words, the contribution margin equals the amount that sales exceed variable costs. This is the sales amount that can be used to, or contributed to, pay off fixed costs.
The concept of this equation relies on the difference between fixed and variable costs. Fixed costs are production costs that remain the same as production efforts increase. Variable costs, on the other hand, increase with production levels.
The contribution margin measures how efficiently a company can produce products and maintain low levels of variable costs. It is considered a managerial ratio because companies rarely report margins to the public. Instead, management uses this calculation to help improve internal procedures in the production process.
The contribution margin is calculated by subtracting total variable costs from total sales revenue.
Total revenues can easily be found on the income statement, but variable costs must be calculated by management.
Contribution Margin Ratio
The contribution margin ratio takes the concept of the contribution margin per unit produced and calculates it as a percentage of the sales price per unit. This shows what percentage of sales is made up of the contribution margin.
Managerial accountants also use the contribution margin ratio to calculate break-even points in the break-even analysis.
The contribution margin income statement separates the fixed and variables costs on the face of the income statement. This highlights the margin.
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