Understanding Contribution Margins

The first step to mastering CVP analysis is understanding contribution margins. At its core, a company’s contribution margin represents the difference between a product’s or service’s revenue and its variable costs. Unlike gross profit, which considers only direct production costs, contribution margin takes into account all variable expenses associated with the production and sale of a particular offering.

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Unit Contribution Margin

A product’s unit contribution margin essentially provides insight into how much each sale contributes to covering a company’s fixed costs and generating profit. The formula for unit contribution margin is:

Unit Contribution Margin = Unit Sales Price – Unit Variable Cost

Note that these amounts are all given on a per unit basis. If a problem provides a total dollar amount for sales or variable cost, that total will need to be converted back to a per unit figure to find unit contribution margin.

(Total) Contribution Margin

Similar to unit contribution margin, a company’s total contribution margin shows how much revenue is left over after covering total variable costs to cover total fixed costs and general a profit. The formula used is:

(Total) Contribution Margin = Sales – Variable Costs

Note that these amounts are totals. If a per unit amount is provided instead of a total, the per unit amount will have to be converted to totals.

Contribution Margin Ratio

The contribution margin ratio shows the relationship between the contribution margin (the difference between total sales revenue and total variable costs) and revenue. It is expressed as a percentage and provides insights into the proportion of each sales dollar that contributes to covering fixed costs and generating profit.

There are two formulas that we should know for calculating the contribution margin ratio:

Formula 1: Per Unit

Contribution Margin Ratio = (Unit Sales Price – Unit Variable Cost) / Unit Sales Price

Formula 2: Totals

Contribution Margin Ratio = (Sales – Variable Cost) / Sales

In essence, you can use the per unit figures or total figures, but you must stay consistent! To understand this concept better, please watch the videos below.

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Click here to access the
Understanding Contribution Margins Spreadsheet
and follow along!

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