Close this search box.

Table of Contents

Contribution Margin


Contribution Margin is a financial metric that measures the profitability for individual items that a company makes and sells. Specifically, it is used to review the variable costs included in the production cost of individual items. In essence, it shows how much of a company’s revenues will be contributing to covering its fixed costs and subsequently towards its profit.


The phonetic pronunciation of “Contribution Margin” is: /kon-truh-byoo-shun mahr-jin/

Key Takeaways

  1. Measures Profitability: Contribution margin is a crucial financial metric that businesses use to decipher how profitability will be affected with each additional unit sold. It solely focuses on the variable costs associated with the production of each additional unit, allowing companies to gauge potential profitability with each sale.
  2. Management Decision Tool: It acts as an essential management decision tool. When making pricing decisions, launching new products, or entering new markets, the contribution margin can provide useful insights for evaluating profit potential and risk evaluations.
  3. Effect of Variable Costs: The contribution margin depends greatly on the company’s variable costs. If the variable costs are high, the contribution margin will be low, reducing the profitability from each additional unit. Therefore, effective management of variable costs is fundamental to improving the contribution margin.


Contribution margin is a critical financial metric in business as it delineates the profitability for individual items that a company makes and sells. Specifically, it is used to review the variable costs included in the production cost of individual items. Understanding the contribution margin is important because it shows how much a company’s sales can contribute towards covering fixed costs and then generating profit. Without contribution margin, a company can’t make pricing decisions, cannot prepare sales strategies and essentially, can’t understand its own potential for profitability. Thus, evaluating the contribution margin helps businesses determine the profitability of individual SKU’s, the break-even point for production and provides essential data for making informed business decisions.


Contribution Margin plays a vital role in helping businesses make key operational decisions. It measures the profitability for individual items that a company makes and sells. Specifically, it’s useful in determining which products or service lines to focus on, based on their contribution margin. A company might opt to promote high-margin items in order to maximize profitability. It also helps the management in evaluating whether to add or subtract a line of business. For instance, if a product contributes negatively to the overall margin, a company might consider dropping that product line.Moreover, contribution margin is also pivotal in determining the break-even point of a business, that is, the point at which the company’s revenues cover all of its fixed and variable costs. It can be particularly useful in cost-volume-profit analysis and deciding pricing strategies. If a firm’s variable costs per unit decrease, the contribution margin per unit will increase, thus decreasing the number of units required to cover fixed costs. Therefore, understanding the concept of contribution margin is imperative for businesses, as it not only helps in boosting profitability but also plays a crucial role in strategic decision making.


1. Manufacturing Company: Suppose a company produces and sells widgets for $20 each. It costs them $5 in direct materials, $4 in direct labor, and $3 in variable overhead costs to make each widget. This means their contribution margin per widget is $20 – ($5 + $4 + $3) = $8 per widget. The contribution margin ratio would then be the contribution margin ($8) divided by the sales price ($20), resulting in a contribution margin ratio of 40%. This implies, for every additional widget they sell, $8, or 40% of the sales price, will contribute to covering fixed costs and generating profit.2. Food Truck Business: Consider a food truck that sells gourmet sandwiches for $10 each. The variable cost incurred on bread, filling, condiments, and packaging material is $3 per sandwich made. This leads to a contribution margin of $10 – $3 = $7 per sandwich. If the food truck’s fixed costs for items like rent and salaries total to $1400 a month, they’d need to sell at least 200 sandwiches in a month ($1400 fixed costs/$7 contribution margin) to break even.3. E-commerce Store: An online retailer sells a product for $100. The variable costs related to that product, including buying from a supplier, shipping, and packaging, total to $60. As such, the contribution margin for each product sold is $100 – $60 = $40. The contribution margin ratio would then be 40%. For every additional product sold, $40 or 40% of the sales price goes toward covering the fixed costs and potential profits.

Frequently Asked Questions(FAQ)

What is the Contribution Margin?

The Contribution Margin is a financial performance measure that evaluates the profitability for individual items produced and sold. Essentially, it’s the revenue remaining for a company after accounting for variable costs of production.

How is the Contribution Margin calculated?

The Contribution Margin is calculated by subtracting variable costs from the sales price of a product. This can be represented through the formula: Contribution Margin = Sales Price per Unit – Variable Cost per Unit.

Does a high Contribution Margin mean a business is profitable?

Not necessarily. A high Contribution Margin signifies each unit sold is providing a high contribution towards covering fixed costs and contributing to profit. However, profitability also depends on total revenue and total costs.

What is the importance of Contribution Margin in business?

Contribution Margin helps businesses to make decisions about pricing, adds or withdraws a product, evaluates the profit potential of different service lines, and to calculate break-even points.

What is a contribution margin ratio, and how does it differ from the contribution margin?

The Contribution Margin Ratio is the percentage of contribution margin to total revenue. It represents the portion of each dollar of revenue that goes towards covering fixed costs and earning profit, unlike the contribution margin that provides the monetary amount towards fixed cost and profits.

Does a negative Contribution Margin mean a business is incurring a loss?

Yes, a negative Contribution Margin indicates that the variable cost of producing a unit is more than the selling price of the product, meaning the business is incurring a loss for each unit sold.

How should businesses use the Contribution Margin to make financial decisions?

Businesses can use Contribution Margin to inform several important decisions like determining the selling price of a product, deciding whether to discontinue a product or service, to analyze the impact of different cost structures on profitability, and to calculate breakeven points for cost-volume-profit analysis.

Related Finance Terms

Sources for More Information

About Due

Due makes it easier to retire on your terms. We give you a realistic view on exactly where you’re at financially so when you retire you know how much money you’ll get each month. Get started today.

Due Fact-Checking Standards and Processes

To ensure we’re putting out the highest content standards, we sought out the help of certified financial experts and accredited individuals to verify our advice. We also rely on them for the most up to date information and data to make sure our in-depth research has the facts right, for today… Not yesterday. Our financial expert review board allows our readers to not only trust the information they are reading but to act on it as well. Most of our authors are CFP (Certified Financial Planners) or CRPC (Chartered Retirement Planning Counselor) certified and all have college degrees. Learn more about annuities, retirement advice and take the correct steps towards financial freedom and knowing exactly where you stand today. Learn everything about our top-notch financial expert reviews below… Learn More