There are so many different calculations involved in setting the pricing for your products or services and it is not easy to keep track of all these values. We’ve created a simple tool that you can use to calculate the contribution margin for different products or services.
Contribution margin is the amount of money you earn that goes towards paying for your fixed costs. Simply put, this is calculated by dividing variable expenses by the number of units sold. However, the calculation is a bit more complicated as you can see later. Don’t worry, it is a no-brainer.
With the contribution margin calculator, you will get the results for a variety of products and services. The outputs can be received in a matter of seconds. Your company can use this as a benchmark to track improvements on each product and even determine which products should be put on sale.
Definition and Importance of Contribution Margin
Before reviewing the calculator, you should know what the contribution margin is. Without further ado, let’s see what it stands for in accounting.
The contribution margin is the difference between the selling price and the variable costs of a product. In other words, it is the gross profit margin of a company. It is also defined as the amount of money left over after paying for all variable costs and fixed costs. Therefore, the variable costs should be deducted.
This calculation can help companies reveal the profitability of their products and estimate the sales revenue. It is a great way to find out how much money each product generates, which can help you make your production more profitable.
The contribution margin is often calculated in percentage terms as a percentage of sales revenue. If a company’s contribution margin was 10% then this means that they are earning 10 cents on every dollar they make in sales. This can be seen as an indication that the company’s pricing may need to be adjusted if it wants to increase its profits.
Contribution Margin Ratio & Contribution Margin: What’s the Difference and How to Calculate Them?
Calculating the contribution margin is fairly easy. This formula involves multiplying the variable costs of units and their selling price by the No. of units sold. This way you will get the total selling revenue. Then the total variable costs should be subtracted from that figure. Take a look below!
Contribution Margin = (Selling Price per Unit * Number of Units) – (Variable Costs per Unit * Number of Units)
Once you have calculated the contribution margin, you will be able to compute the contribution margin ratio. Simply divide your result for the contribution margin by selling price per unit and number of units, i.e., the total revenue. Check the formula below!
Contribution Margin Ratio = Contribution Margin / (Selling Price per Unit * Number of Units)
NOTE: The ratio is expressed as a percentage, while the contribution margin is actually a currency.
Example of How to Use These Formulas
We are going to take an example to help you get a better understanding of how it works. Let’s say you run a small business and produce 10 units of a product. And we will assume that you sell them at $1,000 per unit so that variable costs are $800 per unit.
- Selling price per unit: $1,000
- Variable costs per unit: $800
- Number of units: 10
Contribution Margin = (1,000 * 10) – (800 * 10) = 10,000 – 8,000 = $2,000
Now we will see how the contribution margin ratio is calculated in this example. By using the formula mentioned above, we will get:
Contribution Margin Ratio = 2,000 / (1,000 * 10) = 2,000 / 10,000 = 0.2
If you want to present the ratio as a percent, then you need to multiply it by 100:
Contribution Margin Ratio = 0.2 * 100 = 20%
We hope it’s clear now. Even though it’s not difficult to calculate these values yourself, we recommend that you use the contribution margin calculator.
FAQs
What’s the Purpose of the Contribution Margin?
The contribution margin can be very useful for companies. Actually, every manager should know how to compute the contribution margin. It enables businesses to determine their target income sales and break-evens with ease. Consequently, it helps them make the right decisions about product lines, service and product prices, as well as bonuses or sales commissions.
In addition, the contribution margin plays a vital role in creating break-even analysis. Break-even analysis is a technique that helps in determining the point at which the total costs of a project are equal to the total revenues. It is calculated by dividing the total cost by the total revenue. For example, if your monthly rent is $2,000 and you have an average monthly income of $3,000, then your break-even point will be when you earn $2,000 per month or more.
Contribution Margin – What Does It Tell You?
The contribution margin is an important metric to measure the profitability of a company. It represents the percentage of sales that remain after deducting the variable costs. The contribution margin can be used to compare profitability across different industries or companies, and it can also be used as a benchmark for a company to evaluate its performance against prior periods.
As a matter of fact, it tells you how much money is left after paying for all the costs of production and selling your product. The contribution margin can be calculated for a single product or for all products in a business. It can be calculated by subtracting the variable costs from the total revenue to get a percentage. For example, if your total revenue was $1 million and your variable costs were $500,000 then your contribution margin would be 50%.
Still, we recommend using the aforementioned formula and our calculator as well. This handy tool will not only save you time, but it will also make sure that you always get the correct results when calculating the contribution margin. Try it out!