What is Contribution Margin?

Contribution margin shows how much each sale, product or customer contributes toward covering fixed costs and producing profit. It is calculated as revenue minus variable costs, the costs that rise and fall with sales volume.

Variable vs fixed costs

• Variable: materials, merchant fees, sales commissions, shipping to customers, packaging, marketplace fees
• Fixed: rent, salaried staff, insurance, software subscriptions

Contribution margin differs from gross profit, which subtracts cost of goods sold but may exclude variable selling costs and include some fixed production costs.

Example

An online product sells for $50. Product cost is $18, marketplace and payment fees are $8, packaging and shipping are $7, and advertising averages $5 per sale. Contribution margin is $12 per unit, or 24%. With $12,000 of monthly fixed costs, the business needs 1,000 sales a month to break even; see break-even point.

Why it is useful

• Comparing products, channels or customers on a like-for-like basis
• Deciding whether a discount or promotion makes sense
• Evaluating whether to accept a low-priced order
• Showing how much volume is needed to cover overhead

Building it from the books

Contribution margin requires variable costs coded by product or channel. In practice this means recording marketplace fees, shipping and advertising separately rather than netting them against sales; see our approach to ecommerce accounting.

Limitations

Some costs are partly fixed and partly variable. Make a reasonable split and use it consistently. See also small business financial ratios and the SBA's guidance on managing your finances.

Related terms

• Cost of Goods Sold: Cost of goods sold is the direct cost of the products a business sold during a period.
• Gross Profit: Gross profit is revenue minus cost of goods sold, before operating expenses.
• Break-Even Point: The break-even point is the sales level at which revenue exactly covers all costs, producing neither profit nor loss.

Browse more definitions in the small business glossary.