What is contribution margin and how is it calculated?

Contribution margin is the difference between a product’s or service’s selling price and its variable costs. It represents the amount of revenue that is available to cover fixed costs and generate a profit. Contribution margin can be calculated using the following formula:

Contribution margin = Selling price per unit – Variable cost per unit

In this formula, selling price per unit is the price at which a company sells a unit of its product or service, while variable cost per unit is the cost of producing a unit of the product or service, including direct materials, direct labor, and other variable costs.

For example, if a company sells a product for $100 and the variable cost of producing that product is $50, the contribution margin per unit would be:

Contribution margin = $100 – $50 = $50

This means that for every unit sold, $50 is available to cover fixed costs and generate a profit.

By calculating the contribution margin, a business can determine the profitability of each product or service it offers. It can also help a company to make pricing decisions by understanding how changes in selling price or variable costs will affect its contribution margin and profitability.