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                        Contribution Margin and Contribution Margin Ratio

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                        The Contribution margin is the most basic of all financial measures, and is basically trying to determine the profitability of individual products and/or whole product lines. The contribution margin discovers how much capital is left after subtracting direct variable costs, which can be used to cover fixed costs and generate profits.

                        Variable costs are costs that can be directly coupled to the production of products or services.

                        Variable costs could e.g. be:

                        Direct labor costs
                        Costs of goods sold
                        Transportation costs
                        Direct materials

                        Fixed costs could e.g. be:
                        Advertising costs
                        Different Utilities

                        Below, the formulas for contribution margin and contribution margin ratio are presented

                        Contribution Margin
                        Contribution Margin = Sales - Variable costs

                        Contribution Margin Ratio
                        Contribution Margin Ratio = Contribution margin / Sales

                        Example: Company X sells a product for $1000, and the products variable costs are $250, then company X gets a contribution margin of $750. The contribution margin ratio will then be $750/ $1000 = 75%.

                        When analyzing contribution margin and contribution margin ratios, business leaders can evaluate if e.g. a certain product or product line performs satisfactorily. If the contribution margin is too low, business leaders can seek to minimize variable costs, or try to raise the selling price of the product. If none of the options are feasible, companies may terminate the production of products showing an unsatisfactory contribution margin.

                        Date Created: 2009-11-16
                        Posted by: Admin
                        Contribution Margin and Contribution Margin Ratio

                        Related resources:

                        Return on Investment (ROI)
                        Return on Assets (ROA)
                        Return on Equity (ROE)
                        Return on Sales (ROS)
                        Return on Capital Employed (ROCE)

                        Online MBA, Online MBA Courses, Contribution Margin, Contribution Margin Ratio, Fixed costs, Variable costs


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