Description
The contribution margin is a company’s sales revenue minus variable costs. The balance is used to cover fixed costs (for instance rent), and after that is covered, any balance will be tagged as earnings. Contribution margin is mostly presented as a dollar number or a percentage.
Example
Contribution margin = revenue − variable costs. Suppose a company's product is priced at $20. The per unit variable cost is $4. Thus, its per unit contribution margin will be 20-4 = $16.
Why it matters
Contribution margin can help in gauging how a company's sales, variable costs, and fixed costs can impact its operating profit. It is used to assess how different sales levels may impact a company's profitability. Companies also use contribution margin to determine their break-even point.