What is Contribution Margin Ratio?
The Contribution Margin Ratio (%) represents the product revenue remaining after deducting all variable costs, expressed on a per-unit basis.
How to Calculate Contribution Margin Ratio (Step-by-Step)
The contribution margin ratio (%) expresses the residual profits generated from each unit of product sold, once all variable costs are subtracted from product revenue.
- Variable Costs (VC) → The incurred costs that are directly tied to and fluctuate based upon production volume (i.e. output activity) in the current period. Based on the production output in the given period, a company’s variable costs – such as direct labor and raw material costs – fluctuate either upward or downward, since such costs support the generation of revenue.
- Fixed Costs (FC) → These incurred costs remain relatively the same, regardless of the company’s production volume in the given period. Fixed costs are independent of production volume and are incurred regardless of the circumstances. For instance, a company’s rental expense on an office space must be paid each month whether its sales are thriving or if the company is on the verge of bankruptcy.
The calculation of the contribution margin ratio is a three-step process.
- Step 1 → Calculate the Contribution Margin (Selling Price Per Unit – Variable Cost Per Unit)
- Step 2 → Divide the Contribution Margin by the Selling Price Per Unit
- Step 3 → Multiply the Resulting Ratio by 100 to Convert into Percentage Form
Contribution Margin Ratio Formula
The formula to calculate the contribution margin ratio is as follows.
The resulting ratio compares the contribution margin per unit to the selling price of each unit to understand the specific costs of a particular product.
Since the incremental profit earned on each product sale can be derived from the ratio, the ratio offers useful information that can help guide decisions such as setting product pricing appropriately to ensure a minimum margin is met (and the business model is sustainable).