Contribution Margin

A contribution margin can either be calculated on a gross or a per-unit basis—both figures represent the money you’ve gradually generated for each of the products you’re selling (after you’ve deducted your firm’s fluctuating expenses).

Your contribution margin highlights the section of a product’s sales revenue that isn’t consumed by your variable costs. As such, your contribution margin forms part of your business’ fixed costs.

In short, this is the equation you need to calculate this figure:

Your Price Per Unit – The Variable Cost Per Unit = Contribution Margin

There’s a good chance you’ll have a lower contribution margin if you’re running a labor-intensive company with fewer fixed expenses (by fixed costs we mean one-time expenses like machinery). Whereas, capital-intensive businesses tend to have higher fixed costs and therefore a higher contribution margin.

This figure is essential for entrepreneurs, business owners, and investors because it allows them to analyze how specific products contribute to the overall profit generated. Needless to say, this figure is essential for conducting break-even analyses and planning strategies pertaining to future sales, merchandise, and marketing.

The Uses of Contribution Margin

It doesn’t matter what industry or niche you’re working in, you should be able to reap the benefits of calculating a contribution margin for each of your products.

This figure helps you analyze your best-performing products and from there, you can select the ones you want to create and sell. This is often necessary if you have several similar products all competing for limited resources.

By focusing on products that have proven to be a success, you’re more likely to generate higher profits in the long run. Whereas, you should consider abandoning products with low (or negative) contribution margins because financially, they’re not worth the time and effort.