- What is contribution margin?
- Contribution margin (CM) is the amount each unit sale contributes toward covering fixed costs and generating profit: CM per unit = Selling Price - Variable Cost per unit. Once enough units are sold to cover all fixed costs, each additional unit sold contributes directly to profit.
- How is the CM ratio used in pricing decisions?
- CM Ratio = CM per unit / Selling Price x 100. It tells you what percentage of each sales dollar goes toward covering fixed costs and profit. A higher CM ratio means more of each sale drops to the bottom line. It helps compare the relative profitability of different products.
- What is the break-even point formula?
- Break-even units = Fixed Costs / CM per unit. At break-even, total contribution margin exactly covers all fixed costs and operating income is zero. Selling beyond the break-even point generates profit at the CM per unit rate for each additional unit.
- What is the difference between contribution margin and gross profit?
- Contribution margin separates costs into variable (change with volume) and fixed (do not change with volume). Gross profit separates costs into COGS and operating expenses. In practice, they may differ because some COGS items are fixed (like factory overhead allocated per unit). Contribution margin is more useful for pricing and volume decisions.
