Contribution Margin Ratio is a type of financial metrics that is used by many companies in order to make the decisions based on the discontinuity of selling various products and services. Companies often look for the minimum price at which the products of a company can be sold based on the fixed expense of the business. Low contribution margin helps in turning up of intensive labor services while contributing to the prevalent margin in a more capital intensive industrial business. Hence Contribution Margin analysis helps companies for measuring their leverage in operation. It is the difference between the company’s sales and variable expenses which is expressed in percentage. It generates the total entity while representing the total earnings available to pay the fixed expense.
The formula used for calculating Contribution Margin Ratio is as follows:
Contribution margin ratio= contribution margin/ sales
Where contribution margin = sales minus variable costs.
Contribution margin ratio helps companies to calculate and set their targets in profit potential of a given product.
The formula for contribution margin can be stated as follows:
Contribution margin=($20 sales income - $6 total variable cost) = $14
Following this equation will lead to the result of contribution margin ratio of $14/$20 or 70 percent. This means, 70 percent of each of the product sale is available to contribute towards $31,000 of total fixed expenses that needs to be covered for each month helping to achieve the targeted profit.
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