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Contribution margin - also called Gross profit - is the sales price received minus the variable cost. Below you find an example of contribution margin.
Example of contribution margin
If you sell CDs at $ 25.- on the internet and promote it like this: No
postage and packaging, your calculation could look like this:
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Sales price |
25.00 $. |
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- Purchase price at CD company: |
18.75 $ |
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- Packaging and padded envelope: |
01.00 $. |
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- Postage: |
02.00 $. |
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= Contribution margin: |
03.25 $ (13 %) |
This calculation shows you that each time you sell a CD at 25 $. you have
3.25 $ left. This has to cover other expenses than those related directly to
purchasing, packing and dispatching the CD.
This amount is also called the contribution margin or gross profit.
Contribution ratio
You can also calculate contribution margin as a percentage, then it is called contribution ratio. It is
done like this:
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Contribution margin x 100 / sales price
In the above CD example the contribution ratio is:
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3.25 $ x 100 / 25 $. = 13 %
Contribution margin when selling service
The contribution margin differs substantially between different trades. The
above example generates a relatively modest contribution margin.
Compare this to a consultant giving management and development presentation
which may pay you 1500 $ per presentation. Here you may only have 50 $ of direct
expenses for the cab taking you to the hotel where the presentation is held.
This generates a 1450 $ contribution margin. (97 %).
But then you probably have considerable fixed costs and you cannot expect to
sell presentations 40 hours a week.
The same thing apply to e.g. accountants, lawyers, psychologists and others.
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