Understanding Contribution Margin and Why You Need It
When you run a business, you obviously need to know how profitable it is. You can check your profit margin to understand by how much your revenue exceeds costs.
However, if you’d like to dig deeper and learn how a certain product contributes to your profit, you have to look at the contribution margin.
When you create a product or deliver a service and deduct the variable cost of offering it, the leftover revenue becomes the contribution margin.
So simply put,
Contribution margin= revenue – variable costs
By knowing the contribution margins, you can decide whether to add or subtract a product line, how to price it, and how to structure sales commissions.
If a product’s contribution margin is negative, it means your company is losing money producing it. Your course of action could be to discontinue the product or increase its price. Meanwhile, if a product has a positive contribution margin, you would want to keep it.
However, the first step in calculating for the contribution margin is to use your income statement and identify all your fixed and variable costs. This is not as straightforward as it sounds because it’s not always clear which ones fall into each category.
So if you want to save time and ensure that you get the contribution margins right, get in touch with us so we can help you make informed business decisions.