Contribution margin ratio is a metric that shows what percentage of a company’s revenue remains after variable costs have been deducted. In other words, it measures how much revenue is available to cover fixed costs and generate profit.
Formula
Contribution margin ratio is typically calculated like this:
Contribution margin ratio = (Contribution margin / Revenue) × 100
where:
- Contribution margin = Revenue - Variable costs
- Revenue = Sales revenue from goods or services
Example
A company sells goods for DKK 1,000,000. The variable costs are DKK 600,000.
- Contribution margin = 1.000.000 - 600.000 = DKK 400.000
- Contribution margin ratio = (400.000 / 1.000.000) × 100 = 40 %
This means that 40% of revenue is available to cover fixed costs and generate profit.
Use
The contribution margin ratio is used to assess the profitability of products, customers, or the business as a whole. A high contribution margin ratio means the company has relatively low variable costs compared to revenue, which often provides greater financial resilience.
Key points
- Contribution margin ratio varies between industries - for example, retail often has lower contribution margin ratios than consulting companies.
- It’s a key metric in budgeting and pricing.
- Can be used for break-even calculations: how much revenue the company needs to cover all fixed costs.