Contribution Margin Ratio

Contribution Margin Ratio

In this article, you will discover the items required for the Contribution Margin Ratio, also referred to as the contribution rate.    

Contribution Margin Ratio is simply a percentage consisting of dividing two numbers.  The numbers required include the contribution margin and sales.  So before you can calculate contribution margin ratio, you’ll first need to calculate the contribution margin in dollars.  Below provides an illustration to help you calculate the contribution margin and contribution margin ratio.  

Assume your selling price per unit is $100 and your variable costs are $70 per unit.  Using this information, we can calculate Contribution Margin as $30 per unit ($100 selling price per unit subtract the variable costs per unit = the contribution margin in dollars).  

So what does a $30 per unit contribution margin mean?  Simply put, each time you sell the product for $100, you will have $30 remaining or left over to “contribute” towards your fixed costs ($100 – $70 variable costs = $30 per unit). 

Now let’s turn the contribution margin of $30 per unit into a contribution margin ratio or rate or contribution margin.  To do this, simply divide your contribution margin in dollars by your selling price per unit.  In this example, the contribution margin ratio is 30%.  The contribution margin ratio was arrived at in the following manner.  $30 per unit divide $100 selling price = .30 which is the same as 30%.  

Remember this… a “ratio” or “rate” is always, always, always a percentage.  As a result, the contribution margin ratio or contribution rate must be a percentage.   In this case, the contribution margin ratio or contribution rate is 30%.  So what is the meaning of the contribution margin ratio?   Using the above example, the question would be what does a 30% contribution margin ratio mean.   Below provides a complete explanation.

First, we have to convert the percentage to a number, opposed to a percentage.  To do this, simply remove the percentage sign from 30% and move the decimal two places to the left.  So 30% is actually the same as 0.30 (verbalized as zero decimal 3 zero).  If we were to place a dollar sign in front of 0.30, it would be $0.30 which is actually the same as 30 cents. 

So we just determined that 30% is the very same as 30 cents ($0.30).  Using the same logic, you now know that 60% is the very same as 60 cents, 80% is the same as 80 cents, 20% is same 20 cents and 100% is the same as $1.00 (one dollar).

So in our example, the 30% contribution margin ratio actually means this.  For every $1.00 made in sales, 30 cents is the contribution margin.  Another way to explain a 30% contribution margin ratio is as follows.   For every $1.00 dollar generated in sales, there will be 30 cents remaining which will “contribute” towards paying the company’s fixed costs.

Let’s look at another situation.  Assume total sales for the fiscal period were $100,000 and variable costs total $70,000.  Using these figures, what is the contribution margin and contribution margin ratio?

Total Sales subtract Total Variable Costs divided by Total Sales.   Using the above figures, the contribution margin ratio is calculated to be 30%.  That is, $100,000 total sales subtract variable costs of $70,000 = $30,000.  Now divide the $30,000 by sales of $100,000 to arrive at a contribution margin ratio of 30%.  

To better understand the contribution margin ratio, you may wish to read the article on Contribution Margin.  

If you sell multiple products with multiple selling prices and costs, you will need to develop a weighted average contribution margin ratio.  You can learn more about weighted average selling price and weighted average cost by following the related links.  This concludes our discussion on Contribution Margin Ratio. 

Categories: Financial