Definition of Contribution Margin
Contribution margin is calculated by subtracting variable cost from the sale price of the product. In other words, through a contribution margin, managers calculate the profit left by adjusting the variable cost from the sale of the products.
Formula of Contribution Margin:
C = P – V
C: unit margin
P: unit revenue
V: unit variable cost
Understanding the Contribution Margin:
The organization's net income is its total revenue minus total expenses. Let’s say a company’s total revenue is like total sales generated and expenses are like fixed cost and variable cost. The fixed cost of a company is its machinery or land while variable costs are the cost of material and labor.
Fixed costs do not vary while the variable cost is highly variable according to the production plan. Contribution margin helps organizations to calculate the amount of revenue left over to cover the fixed cost and earn a profit.