Contribution margin

Contribution margin (CM), or dollar contribution per unit, is the selling price per unit minus the variable cost per unit. “Contribution” represents the portion of sales revenue that is not consumed by variable costs and so contributes to the coverage of fixed costs. This concept is one of the key building blocks of break-even analysis.

In cost-volume-profit analysis, a form of management accounting, contribution margin—the marginal profit per unit sale—is a useful quantity in carrying out various calculations, and can be used as a measure of operating leverage. Typically, low contribution margins are prevalent in the labor-intensive tertiary sector while high contribution margins are prevalent in the capital-intensive industrial sector.

Contribution arises in Cost-Volume-Profit Analysis, where it simplifies calculation of net income and, especially, break-even analysis.

Given the contribution margin, a manager can easily compute breakeven and target income sales, and make better decisions about whether to add or subtract a product line, about how to price a product or service, and about how to structure sales commissions or bonuses.

Contribution margin analysis is a measure of operating leverage; it measures how growth in sales translates to growth in profits.

The contribution margin is computed by using a contribution income statement, a management accounting version of the income statement that has been reformatted to group together a business's fixed and variable costs.

Contribution is different from gross margin in that a contribution calculation seeks to separate out variable costs (included in the contribution calculation) from fixed costs (not included in the contribution calculation) on the basis of economic analysis of the nature of the expense, whereas gross margin is determined using accounting standards. Calculating the contribution margin is an excellent tool for managers to help determine whether to keep or drop certain aspects of the business. For example, a production line with positive contribution margin should be kept even if it causes negative total profit, when the contribution margin offsets part of the fixed cost. However, it should be dropped if contribution margin is negative because the company would suffer from every unit it produces.

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