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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.

In a Nutshell

Contribution margin is equal to total sales minus total variable costs. It is the income before fixed costs, hence can also be computed as operating income plus (add back) total fixed costs.

Contribution margin per unit can be calculated as: contribution margin divided by number of units sold, or selling price per unit minus variable cost per unit.

Contribution margin ratio is equal to contribution margin divided by sales.

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 (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 = Total sales - Total variable costs, or

CM = Operating income + Total fixed costs

CM per unit = Contribution margin ÷ Number of units sold; or

CM per unit = (Total 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.

The contribution margin ratio can be computed as: 100% minus the variable cost ratio. For example, if variable cost is 60% of sales, then the contribution margin would be 40% of sales.

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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