In order to allocate the company’s fixed costs a proper understanding of ratio of contribution margin and how to calculate your ratio of contribution margin is necessary that also helps in ascertaining the profits of the company. So, let us study more about the ratio of contribution margin, its formula, calculations as well as importance.
What is the contribution margin ratio?
The contribution margin ratio is the incremental money generated for each product or item sold subsequently subtracting the variable cost from it. Therefore, we can say that this ratio is the amount that remains after subtracting all of the variable costs and variable expenses from the sales revenues of the company. We express the CM ratio in terms of percentage.
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How to calculate the contribution margin ratio?
In order to calculate the contribution margin ratio, you need to subtract the variable cost from the total revenue or sales of the company and divide it by the total revenue. Although in the case of calculating the contribution margin you just need to subtract the variable cost from the total revenue or sales of the company.
Contribution margin ratio formula:
For the CM ratio calculation, we can use the following contribution margin ratio formula as follows:
Contribution Margin Ratio= Contribution Margin/Sales
Or, you can also expand and use the formula as,
Contribution Margin Ratio= Contribution Margin/Selling Price Per Unit * Number of Units
Although, in the above formula we calculate the contribution margin as,
- Contribution Margin = Sales Revenue – Variable Costs
Or, you can also expand and use this formula as,
- Contribution Margin = (Selling Price per Unit * Number of Units) – (Variable Costs per Unit * Number of Units)
So, you can also write down the CM ratio formula as, the compilation of both contribution margin formula as well as the direct CM ratio formula as follows:
- Contribution margin ratio = Sales Revenue – Variable Costs / sales
And use this as contribution margin percentage formula by multiply the formula by 100.
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How to find the contribution margin ratio?
To find the contribution margin ratio, divide the contribution margin by sales. As, the contribution margin ratio formula is:
- (Sales – variable expenses) ÷ Sales
As, in the above figure you can see the X axis has a number of units produced in a company or by the firm and on the other hand the Y axis contains the amount (in $) or the price of the units. Also, you can see that the sale price or at the price at which unit is sold out covers up the variable cost as well as the contribution and further it also contains the fixed cost. So, here we also see that Contribution can be obtained by subtracting variable cost from the sales, which can be depicted in the equation as,
- Contribution = Sales – Variable Cost
Key Points:
- The contribution margin ratio is also recognized by the other names as the CM ratio and the contribution ratio.
- contribution margin ratio is the ratio of contribution margin to the sales.
- It basically depicts the amount of money that a company has to cover up for your fixed cost.
- The companies having low fixed costs have low contribution margins, while the companies with high capital, industrial companies mostly have a high fixed cost and have a high contribution margin.
- The concept of contribution margin helps to study the break-even analysis.
- A higher CM ratio is good as the higher the ratio, the high will be the sales price or money per product sold in order to cover up for other expenses.
Contribution margin ratio Examples:
Example 1: A company JKL Ltd. produces and sells a single unit as a product and has the following information about its expenses:
- The Selling price per unit is $ 40
- The Fixed manufacturing costs per month is $ 28,000
- The Variable manufacturing costs per unit is $ 5
- The Fixed SG&A expenses per month is $ 10,000
- The Variable SG&A expenses per unit is $ 4
- The Fixed interest expense per month is $ 2,000
Solution:
Using the above given information, we will find contribution margin percentage as:
- Contribution Margin = Sales Revenue − Variable Costs
Where,
Sales Revenue = $ 40
Variable Costs = Variable manufacturing costs per unit + Variable SG & A expenses per unit
= $ 5 + $ 4
= $ 9
So, our Contribution Margin = $ 40 – $ 9
= $ 31
Therefore, the contribution margin percentage will be
- Contribution margin ratio = contribution margin / sales
Where,
Contribution Margin = $ 31, and
Sales = $ 40
ratio of Contribution margin = $ 31 / $ 40 X 100
= 77.5 %
This ratio of contribution margin tells us that 77.5 % of the sales revenues (or 77.5 % of the selling price) is available to cover the company’s $ 40,000 of monthly fixed costs and fixed expenses.
- As Fixed cost = ($ 28,000 + $ 10,000 + $ 2,000).
Once the $40,000 has been concealed, then 77.5 % of the revenues will flow to the company’s net income.
Example 2:
Jim & Tim Ltd sells one set of socks for $ 80. The variable costs, which include direct material, direct labor, and variable selling (per socks unit) is $ 35. Calculate the percentage of CM.
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Solution:
The contribution margin is the price minus the variable costs.
contribution margin is $ 80 – $ 35 = $ 45.
For every set of socks that Jim & Tim Ltd sells, $ 45 will go towards their fixed costs.
To calculate Jim & Tim Ltd ratio of contribution margin we use the contribution margin per set of socks and divide it by the price per set of socks, which is $ 45 / $ 80 = 56.25 %.
Jim & Tim Ltd ratio of contribution margin tells the corporation that, for every dollar of revenue a socks makes, 56.25 cents or 56.25 % is the contribution margin. The owner of socks can decide to either use this 56.25 % contribution margin to pay fixed costs or to produce a profit.
Example 3: We are given the number of units of the product as 20,000 while its Selling price per unit is $ 400 and its Variable cost is given to us as $ 150. Calculate its contribution margin as well as ratio of contribution margin.
Solution:
Using the formula to find,
- Contribution Margin = (Selling Price per Unit * Number of Units) – (Variable Costs per Unit * Number of Units)
= (400 * 20,000) – (150 * 20,000)
= 80,00,000 – 30,00,000
= $ 50,00,000
And taking the above vale for the formula as,
- Ratio of Contribution Margin = Contribution Margin / (Selling Price per Unit * Number of Units)
= 50,00,000 / (400 * 20,000) * 100
= 50,00,000 / 80,00,000 * 100
= 62.5 %
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Contribution margin in Excel:
You will notice the following calculations while calculating it in excel.
Example 1: A company JKL Ltd. produces and sells a single unit as a product and has the following information about its expenses:
- The Selling price per unit is $ 40
- The Fixed manufacturing costs per month is $ 28,000
- The Variable manufacturing costs per unit is $ 5
- The Fixed SG&A expenses per month is $ 10,000
- The Variable SG&A expenses per unit is $ 4
- The Fixed interest expense per month is $ 2,000
Solution:
As, we are provided with the following information in excel as,
A | B | |
1 | Selling price per unit | $ 40 |
2 | Fixed manufacturing costs per month | $ 28,000 |
3 | Variable manufacturing costs per unit | $ 5 |
4 | Fixed SG&A expenses per month | $ 10,000 |
5 | Variable SG&A expenses per unit | $ 4 |
6 | Fixed interest expense per month | $ 2,000 |
7 |
Using the above-given information, we will find the contribution margin percentage as:
- Contribution Margin = Sales Revenue − Variable Costs
A | B | |
7 | ||
8 | Variable cost | Variable manufacturing costs per unit + Variable SG&A expenses per unit |
9 | = SUM (B3:B5) | |
10 | $ 9 | |
11 | Contribution Margin | Sales Revenue − Variable Costs |
12 | = B1 – B10 | |
13 | $ 31 | |
14 |
Where,
Sales Revenue = $ 40
Variable Costs = Variable manufacturing costs per unit + Variable SG&A expenses per unit
= $ 5 + $ 4
= $ 9
So, our Contribution Margin = $ 40 – $ 9
= $ 31
Therefore, contribution margin percentage will be
- Contribution margin ratio = contribution margin / sales
A | B | |
14 | the ratio of Contribution margin | contribution margin / sales |
15 | = B13 / B1 * 100 | |
16 | 77.5 % | |
17 |
Where,
Contribution Margin = $ 31, and
Sales = $ 40
ratio of Contribution margin = $ 31 / $ 40 X 100
= 77.5 %
This ratio of contribution margin tells us that 77.5 % of the sales revenues (or 77.5 % of the selling price) is available to cover the company’s $ 40,000 of monthly fixed costs and fixed expenses.
- As Fixed cost = ($ 28,000 + $ 10,000 + $ 2,000).
Once the $40,000 has been concealed, then 77.5 % of the revenues will flow to the company’s net income.
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Importance of contribution margin ratio:
The contribution margin shows a company’s profitability when the company sells its each unit. Therefore, the extent of contribution edge should be adequate enough to cover all the fixed costs of the company as well as it should also contribute towards the company’s profit.
So, by now you know why contribution margin is important as it pays for all the company’s fixed expenses such as labour, rent and utilities, and others that exist even when there is no sales or output produced by the company.
Contribution margin ratio calculator:
You can also use contribution margin ratio calculator online to simplify your calculation that will invariably save up your time and energy involved.
An advantageous ratio calculator of contribution margin will comprise the following fields:
- Selling price per unit.
- The variable cost of goods sold per unit.
- Variable non-manufacturing expenditures per unit.
- Actual or projected units sold.
And also by the calculator you will be able to know the break down as the results will be displayed into the following metrics:
- Contribution margin per unit.
- Total contribution margin.
- Contribution margin ratio.
- Contribution margin percentage.
- Total sales revenue.
- Variable cost per unit.
- Total variable cost.
Conclusion:
An appropriate understanding how to calculate your ratio of contribution margin helps you to allocate the company’s fixed costs. So, by far you know that the CM ratio is equal to contribution margin minus sales, as well as how to calculate contribution margin ratio, or say the contribution margin ratio formula and other related things while reading this article.
Frequently Asked Questions
How do you calculate margin ratio?
For the CM ratio calculation, we can use the following contribution margin ratio formula as follows:
- Contribution margin ratio = contribution margin / sales
Or, you can also expand and use the formula as,
- Contribution Margin Ratio = Contribution Margin / (Selling Price per Unit * Number of Units)
What is the expected contribution margin ratio?
the expected ratio of contribution margin is the same as the ratio of contribution margin, calculated by dividing total contribution margin CM by total units sold.
Why is the contribution margin ratio important?
The contribution margin shows a company’s profitability when the company sells its each unit. Therefore, the extent of contribution edge should be adequate enough to cover all the fixed costs of the company as well as it should also contribute towards the company’s profit.
What is unit contribution margin?
It is the incremental money produced for each product or unit sold after you deduct the variable portion of the firm’s costs.