Definition of Contribution Margin

It should be understood within the context of the economy company, understanding the company as the economic agent that uses factors from production (capital, land or labor) in order to produce and maximize its profits. In this way, a company always wants to lower its costs and increase its profits. Two types of costs are distinguished: variable costs that are subject to production (for example, raw materials premiums) and fixed costs, which are those that do not depend on production (for example, renting a premises).

An economic indicator that allows knowing the business situation

The margin Contribution is the one that contributes to the profits of the company. The contribution margin can be presented in two ways: as a percentage or as a Unit monetary. As this margin is within the context of production, to calculate it we will take the own cost of production, the variable cost.

To represent it as a percentage, what we will do is divide the income for the variable costs and we will subtract 1 from the result of the division. To present it in the form of a monetary unit, we will take the income and subtract the variable costs. On the other hand, the contribution margin can be presented in two different scales: the contribution margin of producing a single product or the contribution margin

global (The latter would be calculated by multiplying the contribution margin in monetary unit by the products produced).

From the theory to the practice

If the variable costs of producing a t-shirt are $ 35 (fabric, dye, ...) and the income for that t-shirt is $ 50 dollars, the contribution margin will be as follows: 50/35 = 1.43, 1.43-1 = 0.43 (43%), so the contribution margin would be 43%. If we want to present it in a monetary unit, it would be: 50-35 = 15. In the case that they produced 200 t-shirts, the percentage would remain the same and we would have to multiply 15 by the number of t-shirts produced (15x200 = 3000).

The profit of the contribution margin

In company economics, the contribution margin is calculated so that this difference is the one that covers the fixed costs not linked to production. In this way, the company will always make a profit if the contribution margin is positive. On the other hand, if a company markets several products, it is very useful to know which of them generates a greater contribution margin.

In general, it is recommended that products or services have a high margin of contribution, but this is not a general rule with absolute value since it depends on each product in particular and the strategybusiness.

Photos: Fotolia - Salita2010 / Rrraum

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