Contribution Margin Calculation

It's all too easy to get caught up in the "bottom line" while assessing your company's financial performance. To put it another way, are you making money or not? If the response is affirmative, many business owners will pat themselves on the back and resolve to continue doing what they're doing. However, there is always space for advancement. And what you're doing right now could not work as the company expands. Contribution margin is a measure to keep an eye on, especially for organisations that generate physical goods.

The contribution margin of a company reveals how much money is left over after variable costs are subtracted from fixed costs. It's a metric that's rarely spoken in public, but that managers and executives use to make decisions.

The contribution margin's overarching purpose is to assist these essential participants in improving the manufacturing process by examining their variable costs and (hopefully) identifying ways to reduce them.

Formula for Contribution Margin

The contribution margin formula is straightforward and only requires a little subtraction. This is how it appears:

Contribution Margin = Net Sales – Variable Costs

Net sales and variable costs, both of which can be found on an income statement, are the two main variables here.

Net Revenues

The term "revenue" is often used to refer to net sales. It's the total amount of money your company made, minus allowances and returns. It's frequently the first item on an income statement to appear before all expenses are deducted to arrive at the "bottom line."

Costs that change over time

Variable costs are also found on the income statement, although they aren't as easy to locate as net sales. Instead, they're frequently listed as line items alongside fixed costs in the cost of products sold.

Adding together all the relevant line items from your income statement and deducting that amount from your net sales may be one way to find your variable expenses.

In general, variable costs are those that fluctuate from month to month, usually in direct proportion to your sales. For example, if you manage a dog grooming facility and have a busy month with more dogs than usual, you'll need to stock up on shampoo to meet demand. In this instance, the shampoo is a variable cost.