The contribution margin ratio is the ratio that we get after subtracting the variable cost and the percentage of the selling price. The contribution margin ratio is helpful to make a decision about the sale whether to continue your offers or you want to fix the prices of the goods and services.
Sometimes it tells that the price of the goods and services are not enough the recover the variable cost of the product. This means that you are going in losses. The contribution margin ratio helps to analyze how much each product sale price is contributed towards the cover the variable cost of the product.
The contribution margin ratio come in the category of:
- The company as a whole( profit of the company)
- A product line
- A single unit of a product
Formula to calculate Contribution Margin Ratio
Contribution Margin Ratio = (Net Sales Revenue -Variable Costs ) / (Sales Revenue)
Variable cost
Variable costs are that cost which comes while producing and selling the goods and services. also, we can say that it is a direct expense of the companies which came at the time of production. The variable cost also depends on the volume of the units produced by the company. If there is high production of the product then the variable cost also increases.
Variable costs are:
- Raw materials cost which is needed at the time producing goods
- Maintenance of machines costs like oil, lubricants
- Salary given to employees per unit completed
- Wages of the employees who are working on an hourly basis.
- Sales Agent salary and commission on every unit sold
- Shipping or transportation expense which is occurred while transferring the goods.
- Electricity and water cost for producing volumes of goods and services
Fixed Cost
Fixed costs are expenses that are fixed in nature. They do not change. If that production of the products increases or decreases this is fixed. With can not avoid the fixed cost expenses of the product.
Fixed costs are:
- Acquisition costs for property, plant, and equipment cost
- Interest rate on a loan
- Insurance Premiums
- Rent cost
- Taxes
- Fixed amount of salary paid to workers or employees for their services,
- General expenses like Electricity, water, and gas which are used in office administration
Case Study of Contribution Margin Ratio
Let’s calculate the contribution margin income of ABC private Ltd. company produces 400 units of product and the selling price per unit is $250.
ContributionMargin = Sales Revenue−Variable expenses
| Total | Per Unit | Percent of Sales | |
| Sales (400 units) | $100,000 | $250 | 100% |
| variable expenses | 60,000 | 150 | 60% |
| Contribution margin | $40,000 | $100 | 40% |
| Less fixed cost | 35,000 | ||
| Net operating income | $5,000 |
Contribution Margin Ratio = (Contribution Margin / Sales revenue) × 100
= ($40,000 / $100,000) × 100
= 40%
Contribution margin ratio can be calculated as per unit :
Contribution Margin Ratio = (Unit contribution margin / Unit selling price) × 100
= ($100 / $250) × 100
= 40%
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