Contribution margin - What is a contribution margin?

Definition: The contribution margin is the marginal profit per unit sale, and is the sum of a company’s turnover minus their direct costs.

The contribution margin is a measure of how much money a company has remaining, after their direct sales costs, in order to pay the company’s fixed costs.

Example: calculating a contribution margin

A company sells Product A for £ 150.00. They have direct costs in terms of purchasing, packaging and freight. The purchase price is £ 60.00, the packaging is £ 5.00 and the freight is £ 10.00 The arithmetic of gross margin will therefore be:

Sales Price = 150 - Purchase price: 60 - Packaging: 5 - Freight: 10 Margin = 75

The company now has £ 75.00 left to cover their fixed costs - such as rent, payroll, etc. If the margin is not high enough to cover the fixed costs, then there will be a deficit in the company. Inversely, there will be a surplus (profit) if the contribution margin exceeds the company’s fixed costs.

Using the contribution margin in comparison

It is not recommended to compare contribution margins across different industries, because the contribution margin can be vastly different depending on the type of business involved.

Some companies may have a high contribution margin, but also many fixed costs - whereas other companies may have low contribution margin and fewer fixed costs. The company's contribution margin will always appear in the profit and loss account.