Contribution Margin: Formula and Analysis

The concept of contribution margin is fundamental in CVP analysis and other management accounting topics.

Contribution margin refers to sales revenue minus total variable costs. It is the amount available to cover fixed costs to be able to generate profits.

Contribution Margin Income Statement

The income statement, when presented in contribution margin format, looks like this:

Sales
xx.xx
Less: Total Variable Costs
xx.xx
Contribution Margin
xx.xx
Less: Total Fixed Costs
xx.xx
Operating Income
xx.xx

Contribution Margin Formula

Contribution margin (CM) is equal to sales minus total variable costs. Also important in CVP analysis are the computations of contribution margin per unit and contribution margin ratio.

CM = Sales - Total variable costs

CM per unit = Contribution margin / Number of units sold; or
CM per unit = (Sales - Total variable costs) / Number of units sold

CM ratio = Contribution margin / Sales; or
CM ratio = CM per unit / Selling price per unit

Contribution margin per unit can also be computed as: selling price per unit minus variable cost per unit.

Similarly, the contribution margin ratio can be computed as: 1 minus the variable cost ratio. For example, if variable cost is 60% of sales, then the contribution margin would be 40% of sales.

Illustration

To illustrate the concepts of contribution margin, consider the following example.

 
Per Unit
 
Total
 
Ratio
Sales (2,000 units)
$20
 
$40,000
 
100%
Less: Variable Costs
9
 
18,000
 
45%
Contribution Margin
$11
 
$22,000
 
55%
Less: Fixed Costs    
10,000
   
Operating Income    
$12,000
   

CM per unit. The unit CM is $11 (i.e., $20 minus $9). Alternatively, it can be computed as $22,000 contribution margin divided by 2,000 units.

CM ratio. The CMR is 55% (contribution margin of $22,000 divided by sales of 40,000). It can also be computed as: CM per unit of $11 divided by selling price of $20. Also, the variable cost ratio is 45%; hence, the CMR can be computed as 1 minus 45% = 55%.

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