Contribution Margin Ratio Formula
The contribution margin ratio (CM ratio) of a business is equal to its revenue less all variable costs, divided by its revenue. It represents the marginal benefit of producing one more unit. Here is the formula for contribution margin ratio (CM ratio):
See an example in Excel here.
Example Calculation of Contribution Margin Ratio
CM ratio = (total revenue – cost of goods sold – any other variable expenses) / total revenue
Contribution margin dollars = $50M – $20M – $5M – $5M = $20 million
Contribution margin ratio = $20M / $50M = 40%
The fixed costs of $10 million are not included in the formula, however, it is important to make sure the CM dollars are greater than the fixed costs, otherwise, the company is not profitable.
The contribution margin is not necessarily a good indication of economic benefit. Companies may have significant fixed costs that need to be factored in.
It can be important to perform a breakeven analysis to determine how many units need to be sold, and at what price, in order for a company to break even. To learn more, check out our Financial Analysis course.
In order to perform this analysis, calculate the contribution margin per unit, then divide the fixed costs by this number and you will know how many units you have to sell to break even.
Building on the above example, suppose that the company sold 1 million units. That means the CM per unit is $20. Fixed costs are $10 million so the company has to sell 500,000 units to break even ($10 million / $20 per unit = 500,000).
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CFI is the official global provider of the Financial Modeling and Valuation Analyst designation and is on a mission to help you Advance Your Career. To learn more about other types of financial analysis you may want to check out these additional CFI resources:
- Profit Margin
- Return on Ad Spend
- Leverage Ratios
- What is Financial Modeling
- Financial Modeling for Dummies
- How to be a great financial analyst
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