Contribution margin is a financial tool used by businesses during break-even analysis. Break-even analysis helps businesses determine the point at which revenues equal costs. The contribution margin tells a business the amount of revenue generated by selling a unit of a product after deducting the variable expenses. You can calculate this contribution margin for a new product using some basic cost data and revenue information.
1. Determine the sales price for the new product. For example, assume the new product sells for $25.
2. Determine the variable costs of producing the new product. Variable costs are the costs for the new product that do not change with production changes. Examples of variable costs include materials used to produce the new product and hourly wages paid to produce the product. For example, assume the variable costs of producing the new product are $15.
3. Subtract the variable costs of producing the new product from the sales price of the new product. Continuing the same example, $25 - $15 = $10. This figure represents the contribution margin for the new product.
- Businesses commonly use the contribution margin when determining a pricing strategy for a new product. Businesses can also convert the contribution margin figure to a percentage by dividing the contribution margin by the sales price of the product. Continuing the same example, $10 / 25 = 40 percent. Once converted to a percentage a business can evaluate the actual contribution margin percent against other products sold by the business. Many businesses like to maintain a contribution margin percent above a certain threshold target for all products sold by the business.
- "Principles of Finance"; Scott Besley and Eugene Brigham; 2008
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