Contribution Margin
What each sale leaves over to pay the fixed bills and make a profit.
In your head, jot if needed · no calculator why?
Opens at level 14. You're level 1. You can read and practice here now.
the idea
Contribution is what a sale leaves after its variable costs, the costs that come with each sale. It is not profit yet. All the contributions together first pay the fixed costs, like rent; what is left is operating profit.
Greenline, a made-up plant-care business, charges $500 a month and spends $200 serving each customer, so each contributes $300. Forty customers contribute $12,000, and after $6,000 of fixed costs the profit is $6,000.
The contribution margin ratio is contribution ÷ price: 60% here. Gross profit is a different number: revenue minus cost of goods sold.
techniques
Price minus every variable cost
- Add up every cost that comes with each sale.
- Subtract that total from the price.
- Leave out fixed costs like rent. They do not come with each sale.
worked example
A service sells for $240. Variable costs are $70 of materials and $30 of travel per job. Rent is $1,200 a month. What does each job contribute toward fixed costs and profit?
- Variable costs: $70 + $30 = $100.
- $240 − $100 = $140. Rent stays out.
Answer: $140
Contribution as a share of price
- Contribution: price minus variable cost.
- Divide it by the price, not by the variable cost.
- The percent says how many cents of each sales dollar are left for fixed costs and profit.
worked example
A cleaning visit sells for $80 and uses $20 of variable costs. What is its contribution margin ratio, as a percentage?
- $80 − $20 = $60.
- $60 ÷ $80 = 0.75 = 75%.
Answer: 75%
Then take off the fixed costs
- Contribution per customer × the number of customers.
- Subtract the fixed costs.
- If the fixed costs are bigger, it is a loss: use a minus sign.
worked example
25 customers each pay $400 a month and each costs $150 in variable costs. Fixed costs are $5,000 a month. What is monthly operating profit?
- Each contributes $400 − $150 = $250.
- 25 × $250 = $6,250.
- $6,250 − $5,000 = $1,250.
Answer: $1,250
watch out for
- Subtracting a monthly cost like rent from a single sale. Fixed costs come out of the total, once.
- Calling contribution profit. Greenline contributes $12,000, but its profit is $6,000 after fixed costs.
- Giving the variable-cost share as the ratio, or dividing by the variable cost. The ratio divides contribution by price.
- Mixing up the subtotals. Revenue minus cost of goods sold is gross profit; minus operating expenses, operating profit; minus interest and taxes, net income.
practice
Contribution per sale
worked example
A product sells for $980. Variable costs are $332 of materials and $211 of packaging per unit. Rent is $3,000 a month. What does each unit contribute toward fixed costs and profit?
Answer: $437.00
- Contribution = price − all variable costs = $980 − ($332 + $211) = $980 − $543 = $437.
- Rent is fixed, so it isn't subtracted per unit.
Contribution margin ratio
worked example
A lawn-care plan sells for $170 and uses $68 of variable costs. What is its contribution margin ratio, as a percentage?
Answer: 60%
- Ratio = contribution ÷ price = ($170 − $68) ÷ $170 = $102 ÷ $170 = 60%.
- Each sales dollar leaves 60 cents for fixed costs and profit.
Operating profit from contribution
worked example
153 customers each pay $800 a month and each costs $460 in variable costs. Fixed costs are $4,000 a month. What is monthly operating profit?
Answer: $48,020.00
- Total contribution = 153 × ($800 − $460) = 153 × $340 = $52,020; minus fixed $4,000 = $48,020.
Contribution, gross profit, or net income?
worked example
A $1,650 contract has $540 of costs that rise and fall with each customer. What is the $1,110 difference called?
- Contribution
- Net cash flow
- Net income
- Gross profit
Answer: Contribution
- Price minus the costs that move with each unit is contribution: $1,650 − $540 = $1,110.
- Gross profit subtracts cost of goods sold instead, which can include some fixed costs, so the two can differ.