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What is Contribution Margin?

Contribution margin is the amount left over from a sale after variable costs are subtracted, available to cover fixed costs and then generate profit. It can be expressed per unit, as a total, or as a ratio of sales. It is the figure that drives break-even and pricing decisions.

The contribution margin answers a practical question: how much does each sale actually contribute toward keeping the business alive? If a product sells for €200 and costs €120 in variable costs, its contribution margin is €80. That €80 first goes to paying rent, salaries and other fixed costs; whatever remains is profit.

The contribution margin ratio, the margin divided by the selling price, is just as useful. At a €200 price and €80 margin, the ratio is 40%, meaning forty cents of every euro of sales is available for fixed costs and profit. Comparing the ratio across products shows which items genuinely pay the bills rather than just generate revenue.

Example

A product sells for €200 with €120 of variable costs, leaving an €80 contribution margin. If the business's fixed costs are €8,000 a month, it must sell 100 units to break even, because 100 units times €80 exactly covers the €8,000.

Questions

What is the difference between contribution margin and gross margin?

Contribution margin is revenue minus variable costs; gross margin is revenue minus cost of goods sold, which may include some fixed production costs. Contribution margin is used for break-even decisions, while gross margin is a broader measure of production profitability.

How is contribution margin used to find break-even?

Break-even units equal total fixed costs divided by the contribution margin per unit. This tells you how many sales are needed before the business covers its fixed costs and starts making profit.

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