Abbreviated as CM by Abbreviationfinder, the contribution margin is an indicator that shows how much revenue is left over from the sale of products or services to pay the fixed costs of the business and generate profit. Also called gross gain or gross profit, the contribution margin is calculated by subtracting the sum of expenses and variable costs from revenue.
Variable costs and expenses are those that have a direct relationship with the sales volume of the product. That is, the more products are sold, the greater these expenses will be. Examples of costs include raw materials, water and energy used in manufacturing. Taxes on sales and commission paid to sellers are examples of variable expenses.
In addition to these expenses, companies also have so-called fixed costs and expenses, which are those that do not depend on the volume of products sold. This is the case of renting space and paying employees who do not work directly in production or sale, as is the case with administrative personnel.
What is the contribution margin for?
The contribution margin is a managerial tool that allows you to see if the revenue left over from the sale of products or goods is sufficient to cover the fixed expenses of the business. It is through this analysis that one can understand why a company that sells well cannot generate profit for its partners.
The concept of contribution margin refers to the entire range of products or services offered by the company. If this calculation considers the weight that each product has in total revenue, the weighted contribution margin is obtained.
It is also possible to calculate the unit contribution margin, that is, for each product separately. This calculation shows how much each product contributes to the final results, ensuring that none of them are making a loss.
Knowing the contribution margin is essential for pricing products. In addition, from the contribution margin, the entrepreneur is able to calculate the financial break-even point. By definition, the break-even point is one where revenue equals costs and expenses. It allows to know the minimum quantity of products to be sold so that the business is not in the red.
If the business is not making a profit, the entrepreneur can look at ways to increase his contribution margin. This can be done either by adopting a more balanced selling price or by reducing variable expenses.
How to calculate contribution margin
The contribution margin is calculated in a simple way. In the case of the unit contribution margin, it is necessary to know the selling price (PV), the variable cost (CV) and the variable expense (DV). With these data, just apply the following formula:
MC = PV – (CV + DV)
For example, if a company buys a t-shirt for R $ 20 and resells it for R $ 50, paying 10% tax and 3% commission to sellers, we have:
PV = 50
CV = 20
DV = 0.10 x 50 + 0.03 x 50 = 5 + 1.50 = 6.50
MC = 50 – (20 +6.50) = 50 – 26.50 = 23.50
That is, each shirt has a unit contribution margin of R $ 23.50. To find the percentage of the contribution margin, just divide the amount calculated by the sale price of the shirt and multiply by 100. In this example, the contribution margin of the shirt is 47%.
With the calculation of this percentage, you can easily find out the total contribution margin from the sale of these t-shirts to the company. As the cost, tax and commission are proportional, just apply the percentage of the MC on the total revenue obtained from the sale of this product. Thus, if the company sold 157 t-shirts at R $ 50 each in one month, it received a total of R $ 7,850. Your contribution margin for the entire operation will therefore be 47% of that amount, which is R $ 3,689.50.
Assuming that this company only has this product in the catalog, for it to make a profit, its fixed cost should be less than R $ 3,689.50. The difference between this value and the fixed cost is the entrepreneur’s profit.
If the company has a wide range of products, the best way to calculate the total contribution margin is using data from the accounting reports. Thus, instead of the unit sale price, sales revenue is used, from which the total values of expenses and variable costs are subtracted, applying the same formula.
The profit margin is an indication of how much the company is profitable in the activities it carries out, in percentage values.
This margin serves to determine the value that a product should be sold, which is considering all the costs that the company has, whether these variables, fixed, taxes or depreciation, as examples:
- Operational costs;
- Depreciation and amortization costs;
- Spending on raw materials or goods;
- Tax expenses (such as PIS, COFINS, ISS, Income Tax, among others).
The price that a company sells its products is above the costs and expenses that it had to produce. If it is below the expenses it has a loss. In simple terms, the profit, also known as the result of the year, is calculated from:
Net income = Net sales (Revenue) – (Total Costs and Expenses)
If this result is equal to zero, that is, sales and costs with the same values, the business has no profit or loss and is in its accounting balance point.
Profit Margin Calculation
The simplest way to calculate the profit margin is using the formula:
From the top of the formula, you can see that the result will be the company’s total net profit.
With this, the result is the percentage of the company’s profit margin, which we can observe taking as an example a net profit of R $ 650,000.00 with revenues of R $ 1,500,000.00 from a business. Stay with:
ML = 650,000 / 1,500,000 x 100% = 43.33% profit margin.
The interpretation of this result is that “for every R $ 1.00 sold, the company has about R $ 0.43 in profit”.
The same can be done for a separate product. Just consider the profit and revenue you had on a commodity.
Gross profit margin
The profit margin subtracts all costs and expenses, making it known as “net profit margin”. On the other hand, it is also possible to obtain the gross margin using the formula:
This time we only consider the operating costs for the calculation, that is, the cost of producing and the profit on that production. In the case of companies that only buy goods to resell later, this calculation shows the profit that the business has on the products sold.
In the case of a retailer that buys goods in a given month for R $ 150,000.00 and resells them for R $ 230,000.00 it obtains a gross margin of:
MB = (230,000 – 150,000) / 230,000 x 100% = 34.78%
This result indicates the gross profit of this company that is interpreted as that “for each R $ 1.00 sold the company generates gross profits of R $ 0.34”.
When considering all the other costs of this same company for the calculation, we return to the concept of net margin, which if it is well below 34.78% the company will be far from an ideal profit margin.