contribution margin

(noun)

In cost-volume-profit analysis, a form of management accounting, contribution margin is the marginal profit per unit sale.

Related Terms

Examples of contribution margin in the following topics:

  • Break-Even Analysis

    • To find the amount of units required to be sold in order to break even, we simply divide the total fixed costs by the unit contribution margin.
    • Unit contribution margin can be thought of as the fraction of sales, or amount of each unit sold, that contributes to the offset of fixed costs.
    • When sales have exceeded the break-even point, a larger contribution margin will mean greater increases in profits for a company.
    • Contribution margin (C) is the unit net revenue (P = price) minus unit variable cost (V = variable cost).

  • Combining Operating Leverage and Financial Leverage

    • Fully derived, we see that to multiply Degree of Operating Leverage and Degree of Financial Leverage, we subtract fixed costs and interest expense from the total contribution margin (revenue minus variable cost times the number of units sold), and divide total contribution margin by this result.

  • Defining Operating Leverage

    • In other words, because variable costs are reduced, each sale will contribute a higher profit margin to the company.
    • The DOL tells us, as a percentage, that for a given level of sales and profit, a company with higher fixed costs has a higher contribution margin - the marginal profit per unit sold.
    • Therefore, its operating income increases more rapidly with sales than a company with lower fixed costs (and correspondingly lower contribution margin).

  • Sales Forecast Input

    • Target volume, price, and contribution margin per unit are the key inputs to a sales forecast.
    • Target Volume = [Fixed costs + Target Profits] / Contribution per Unit
    • Target Revenue = 100 * [ { Fixed Costs + Target Profits } / Contribution Margin ]

  • Benefits and Risks of Operating Leverage

    • When considering the benefits of operating leverage, it is appropriate to consider the contribution margin, or the excess of sales over variable costs.
    • When variable costs are lower, the contribution of sales to profits will be greater.
    • Therefore, once a certain break-even point is reached, the contribution that sales make to profits is much higher than it would be if a greater portion of the costs were variable.

  • Profit Margin

    • Profit margin is one of the most used profitability ratios.
    • The higher the profit margin, the more profit a company earns on each sale.
    • The gross profit margin calculation uses gross profit and the net profit margin calculation uses net profit .
    • The profit margin is mostly used for internal comparison.
    • A low profit margin indicates a low margin of safety.

  • Tax Deductions

    • A company's marginal tax rate is 35%.
    • However, to be deducted, the expenses must be incurred in furthering the business, such as it must contribute to profit.
    • The marginal tax rate is dependent upon a jurisdiction's tax structure, usually referred to as tax brackets.
    • For example, a tax credit of $1,000 reduced taxes owed by $1,000, regardless of the marginal tax rate.
    • This graph plots the marginal income tax rates for the top tax bracket in the US from 1913 to 2009.

  • Return on Common Equity

    • ROE is the product of the net margin (profit margin), asset turnover, and financial leverage.
    • Also note that the product of net margin and asset turnover is return on assets, so ROE is ROA times financial leverage.
    • For example, if the net margin increases, every sale brings in more money, resulting in a higher overall ROE.
    • Increased debt will make a positive contribution to a firm's ROE only if the matching return on assets (ROA) of that debt exceeds the interest rate on the debt.

  • Overview of Merchandising Operations

    • Merchandising is any practice which contributes to the sale of products to a retail consumer.
    • In the broadest sense, merchandising is any practice which contributes to the sale of products to a retail consumer.
    • Merchandising is any practice which contributes to the sale of products to a retail consumer.

  • Operating Margin

    • The operating margin (also called the operating profit margin or return on sales) is a ratio that shines a light on how much money a company is actually making in profit.
    • For example, an operating margin of 0.5 means that for every dollar the company takes in revenue, it earns $0.50 in profit.
    • However, the operating margin is not a perfect measurement.
    • Furthermore, the operating margin is simply revenue.
    • The operating margin is found by dividing net operating income by total revenue.