It is that amount of sales revenue that is not used up in the variable costs and hence can be used to cover the fixed costs. Contribution margin can be calculated for per unit of sales of a product or in bulk.
Unit Contribution Margin = Unit Sales Price – Variable Cost per Unit
Total Contribution Margin = Total Sales – Total Variable Cost
Total Contribution Margin = Unit Contribution Margin x Number of Units Sold
Contribution margin can also be defined as the marginal profit on per unit of sale of a product. Low contribution margins are earned in labour-intensive tertiary sectors and high contribution margins are earned in the capital-intensive industrial sectors. Calculation of contribution margin allows one to find out the profitability of products.
If a company notices that the contribution margin on one of its products is less than the industry average, it can adopt one of the following methods to fix the situation:
1. Variable Cost of the product may be reduced
2. Sales Price may be increased
3. Product may be taken off the market
For example, suppose you want to calculate the total contribution margin (CM) on a toothpaste tube.
Price per Unit: Rs. 20
Units Sold: 800
Total Variable Cost = Rs. 8,764
Total CM = Total Sales – Total Variable Cost
Total Sales = Price per unit x Number of units = 20 x 800 = Rs. 16,000
Total CM = 16,000 – 8,764 = Rs. 7,236
Unit CM = Total CM / No. of units = 7,236/800 = 9.045