By James Bell
Contribution margin in it’s simplest form is total sales minus total variable costs but it can also be expressed as a ratio. This margin is what is left over to pay fixed costs and for capital. This is different than Gross Margin in that GM uses COGS instead of variable costs. COGS does not equal variable costs and the two terms cannot be used interchangeably because COGS does typically contain some fixed costs. CM is often used to determine the break even point in either units or dollars.
We’ll cover 2 different methods of breaking CM down by unit. After that we’ll step it up by taking a look at weighted average CM. Finally, we’ll go over a couple of different ways of calculating the CM ratio.
Total Variable Costs
We really mean net sales here.
These can include both direct and indirect variable costs. Take a look at our article on Variable Costing for more detail.
Sales price per unit
Variable cost per unit
Total Contribution Margin
Total CM per Unit
Here we add together all the products of each CM per unit times total units. We divide this total by the total number of units. If you have worked with weighted averages before you may be asking where the weights are. The weighting is built into the numerator as a product when we multiply each CM times the total number of units. We then divide this sum of weighted products by the total number of units to get our average.
This is the Contribution Margin represented by a percentage of sales.
That was a lot of different looks and hopefully not too confusing. Having a lot of different ways of looking at the same data gives analysts and decision makers new insights and make comparisons in different ways. You’ll notice that that some of these formulas use other formulas as variables. We can use these smaller functions to drill down into root cause analysis and understand the drivers. This should allow us to better align metrics to goals, compare alternatives, and assign resources accordingly.
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