Answers the Question
How financially beneficial is each sale to my bottom line?
Calculator for Contribution Margin Ratio
What Is the Contribution Margin Ratio?
The contribution margin ratio provides insight into the profitability of each sale. Fixed costs are excluded from the calculation, because they will need to be paid for, whether any items are sold or not.
All things being equal, the higher the value, the better the health of the company.
Why Is it Important?
- If a producer doesn't know the contribution margin ratio for its products, it may produce products that do nothing positive for the bottom line.
- Additionally, it may not feel the need to make investments into fixed costs, so as to improve efficiency and optimize resource allocation.
Formula(s) to Calculate Contribution Margin Ratio
- CONTRIBUTION MARGIN RATIO = (SALES REVENUE - VARIABLE COSTS) / SALES REVENUE
- Ignoring fixed costs when evaluating the state of a business. A firm with an excellent contribution margin could still be in financial trouble if its fixed costs are extremely high.
- Not considering the quantity of goods sold. The sale of a single unit with an excellent contribution margin ratio is likely a worse outcome than the sale of a million units with a slightly lesser contribution margin ratio.
- Not considering the strategic reason for product production. A company may have a reason to produce goods with poor contribution margin ratios if doing so protects other business interests.