Contribution Margin
Concept summarized by Sam Mishra, MBA (MIT Sloan)
Contribution Margin is defined as the difference between Revenue and Variable Costs. Alternately, contribution margin ratio calculates as follows:
Contribution Margin Ratio = (Revenue - Variable Costs) / Revenue
For those of you who have studied any accounting, COGS (Cost of Goods Sold) and SG&A (Sales, General, and Administrative) are standard accounting terms. Usually, COGS is a variable cost. However, some SG&A components like Administrative costs, and base salary of the sales personnel can be fixed where as sales commissions can be variable. Calculating the contribution margin ratio regularly provides the management an idea as to whether the firm is paying too much or too less in sales commissions, for example. For a firm with multiple product lines, calculating the contribution margin ratio for each product line can provide valuable insights for the management as to which product lines contribute more to the company's bottom line, which product lines are not as profitable, etc.
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