Contribution margin

Contribution margin is a key figure that gives insight into how much of the sales revenue is available to cover fixed costs, once the variable costs have been deducted. It is a way of measuring the profitability of a product or service, before fixed costs and tax are taken into account. Put simply, it tells us how much each unit sold contributes towards covering the fixed costs and generating a profit.

How is the contribution margin calculated?

The contribution margin is calculated with a simple formula:

Selling price – Variable costs

If we want to find the contribution margin per unit, we divide by the number of units sold.

Why does the contribution margin matter?

• Budgeting and pricing. Understanding the contribution margin helps businesses set the right selling price and establish sales targets. It helps determine how much has to be sold in order to reach break-even or achieve the desired profit.
• Decision-making. It gives valuable insight into which products or services contribute most to the business's profitability. This can lead to strategic decisions to focus on certain products or services, or to reconsider the cost structure.
• Cost management. By analysing the variable costs that affect the contribution margin, a business can identify opportunities for cost reductions that can improve profitability.

Tips for improving the contribution margin

• Reduce variable costs. Look for ways of making production more efficient, negotiate better prices with suppliers, or find cheaper raw materials that do not compromise quality.
• Raise the selling price. If the market allows it, a moderate price increase can improve the contribution margin considerably, especially for products or services with low price sensitivity.
• Optimise the product mix. Focus on selling products with a higher contribution margin. This may mean encouraging the sale of more profitable goods or services.

Read more about how the key figures in Capassa keep the contribution margin up to date automatically.