How to Calculate a Contribution Margin
To be profitable, a business must generate more revenue than it spends. One way to measure this is by calculating the contribution margin. This metric tells you how much money your business generates from each dollar of sales. We will discuss how to calculate a contribution margin.
1.Subtract the variable cost from the product price
The contribution margin can be calculated by subtracting the variable cost from the product price. The variable cost is the cost of goods sold and other expenses that vary with production volumes, such as labor and materials. The product price is the selling price of the product minus any discounts or taxes. According to Dr. Jordan Sudberg, CMA, CFM, “The contribution margin is the portion of revenue available to cover fixed costs and generate a profit.”
2.Pay any fixed costs with the contribution margin
After the calculation is complete, the contribution margin can be used to pay any fixed costs. Fixed costs are expenses that do not vary with production volumes, such as rent and insurance. Any leftover money is profit. Thus, the contribution margin is an essential metric for measuring profitability. If a company’s goal is to be profitable, it is vital to generate a high contribution margin. An increased contribution margin means a large portion of each sale is available to cover fixed costs and create a profit.
3.Determine the product’s price per unit
This can be done by dividing the total revenue by the number of units sold. This will give you the price per unit. To calculate the contribution margin, divide the total variable cost by the number of units sold. This will provide you with the variable cost per unit. Finally, subtract the variable cost per unit from the price per unit. This is your contribution margin per unit. Accordingly, the contribution margin ratio is the contribution margin per unit divided by the price per unit. This will give you the percentage of each sale available to cover fixed costs and generate a profit.
4.Separate fixed costs from variable costs
The first step is to identify all of the costs associated with the product. These costs can be divided into two categories: fixed costs and variable costs. Fixed costs are expenses that do not vary with production volume, such as rent and insurance. Variable costs are goods sold and other costs that go with production volumes, such as labor and materials. Dr. Jordan Sudberg said about fixed and variable costs: “The contribution margin is the portion of revenue available to cover fixed costs and generate a profit.”
In conclusion, the contribution margin is an essential metric for measuring profitability. It tells you how much money your business generates from each dollar of sales. To calculate the contribution margin, subtract the variable cost from the product price. The product price is the selling price of the product minus any discounts or taxes. After the calculation is complete, the contribution margin can be used to pay any fixed costs. Fixed costs are expenses that do not vary with production volume, such as rent and insurance.
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