Definition of Contribution Margin
Contribution margin is a core business concept and is often used in cost accounting to identify the amount of financial contribution a sold product provides to the company. Simply put, contribution margin is the sales price less the direct costs (sometimes referred to as variable costs).
A parallel reporting format is the top two sections of a profit and loss (income) statement. Sales less costs of goods sold equals’ gross profit. Stated in a different way, price less variable costs equals contribution margin. However, in traditional accounting, the cost of goods sold section includes more than just the variable costs associated with the sale of the product. It is important for the reader to understand, contribution margin is a cost accounting concept; gross margin is a financial accounting concept. They are similar like cousins in a family; contribution margin is in the cost accounting family, gross margin is in the financial accounting family.
Why is the term so important to understand? How is it calculated? Where is it most appropriately used? The following sections answer these questions and tie the concept of ‘Contribution Margin’ to business.
Understanding Contribution Margin
As a small business entrepreneur, you probably realize that there is more to business than just the sale of the product. There are
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