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Financial metrics glossary

Contribution margin: definition, formula and example

Contribution margin is the revenue left after subtracting the costs that rise and fall with each sale. It is revenue minus variable costs, and it shows how much each sale contributes toward covering fixed costs and then toward profit.

Updated

Formula

  • Contribution margin = Revenue − Variable costs
  • Contribution margin ratio = Contribution margin ÷ Revenue × 100%
  • Break-even revenue = Fixed costs ÷ Contribution margin ratio

Worked example

Illustrative

ILLUSTRATIVE · round numbers, not the sample company

Northbridge Analytics, the fictional company in the Financial Analyst's public sample, books its costs as cost of goods sold and operating expenses, not as variable and fixed, so this example uses round numbers for one month of a business that splits them:

Line Month
Revenue $200,000
Materials and delivery (variable) $70,000
Sales commissions (variable) $16,000
Card processing fees (variable) $4,000
Salaries, rent and software (fixed) $85,000
  1. Variable costs = $70,000 + $16,000 + $4,000 = $90,000
  2. Contribution margin = $200,000 − $90,000 = $110,000
  3. Contribution margin ratio = $110,000 ÷ $200,000 × 100% = 55.0%
  4. Break-even revenue = $85,000 ÷ 55.0% = $154,545

Contribution margin: $110,000 (55.0% of revenue)

Operating profit is the contribution margin less the fixed costs: $110,000 − $85,000 = $25,000. Each extra $1 of sales adds $0.55 to it.

How to read it

  • Contribution margin splits costs differently from gross margin. Gross margin subtracts cost of goods sold, which can include fixed production costs; contribution margin subtracts only variable costs, including variable selling costs such as commissions and card fees.
  • The ratio is what each extra dollar of sales adds to profit once fixed costs are covered. Two products with the same price can contribute very different amounts.
  • Deciding which costs are variable is a judgement. A cost that is fixed over a month can be variable over a year, so state the split and keep it the same from period to period.
  • It is a tool for decisions at the margin: prices, discounts, which products to push, and how much revenue it takes to cover the fixed costs.

Original research: Financial benchmarks for small US public companies, by industry →

Where it shows up in the monthly management report

The report does not print a contribution margin: it follows your books, which classify costs as cost of goods sold and operating expenses, not as variable and fixed.

Its “Monthly economics” page breaks revenue and direct costs into their lines, and the “Margin: from revenue to result” chart shows each step from revenue to the result as a share of revenue — the inputs for a contribution margin once you mark which costs vary with sales.

  • Open the sample workspace — a fictional company's books, worked by the Financial Analyst, with its monthly report. No signup.
  • The Financial Analyst — what it reads from your accounting system, what the report contains and what it costs.

Frequently asked questions

What is the difference between contribution margin and gross margin?

Gross margin subtracts cost of goods sold as the books classify it. Contribution margin subtracts variable costs only, wherever they sit in the books: it leaves out fixed production costs and takes off variable selling costs such as commissions.

What counts as a variable cost?

A cost that rises and falls with each sale: materials, purchased goods, delivery, payment processing fees and sales commissions. Rent, salaries and software subscriptions are usually fixed.

How do you find break-even revenue from the contribution margin?

Divide fixed costs by the contribution margin ratio. With $85,000 of fixed costs a month and a 55% ratio, the business breaks even at about $154,545 of monthly revenue.

Can contribution margin be negative?

Yes, when variable costs exceed the price. Each sale then loses money before any fixed cost is paid, and selling more makes the loss larger.