Contribution margin

Did you know that 60% of small businesses fail due to poor financial management? One useful metric to help improve financial decision-making is the contribution margin. It’s the portion of your sales revenue left after covering variable costs, and it’s critical for understanding how much money is available to cover fixed costs and generate profit.

What is Contribution Margin?

The contribution margin is calculated as:

Contribution Margin = Total Sales Revenue – Total Variable Costs

Costs fall into two categories:

• Fixed Costs: These stay constant (e.g. rent, payroll)

• Variable Costs: These fluctuate based on sales (e.g. raw materials, direct labour, sales commissions)

Why It Matters

Knowing your contribution margin allows you to:

• Understand how much revenue is available to cover fixed costs.

• Calculate your breakeven point—the sales needed to cover all costs and start making a profit.

Example:

• Sales: $500,000

• Variable Costs: $350,000

• Contribution Margin: $150,000 (30%)

If fixed costs are $180,000, your breakeven point is:

Breakeven Revenue = $180,000 / 30% = $600,000

At $500,000 in sales, the business is still losing money.

However, if variable costs drop to $300,000, the contribution margin increases, and the breakeven point lowers to $450,000. Now, at $500,000 in sales, you’re in profit.

Conclusion

Understanding your contribution margin is essential for pricing, cost management, and overall financial health. By calculating it, you can make better decisions to ensure your business stays profitable.

If you’d like to learn more about how to calculate and apply contribution margin in your business or need assistance with financial planning, please reach out to contact us.