The contribution margin of a company is its revenue minus its variable costs, expressed in a percentage. Variable costs include expenses such as raw materials and utility costs. Revenue is the money a company receives for its regular business activities. Revenue is also referred to as gross income.
When a company calculates its contribution margin, it is calculating how much revenue each product earns for the company. The equation to calculate the contribution margin is individual product revenue minus variable costs associated with the individual product divided by revenue. If the company determines that the contribution margin is low for a particular product, it may decide to discontinue selling the item.
Contribution Margin Adjustments
If a company finds that the contribution margin for a particular product is low, the company can attempt to adjust the inputs, such as variable costs, in the contribution margin equation. For example, a company sells one brand of imported perfume and its shipping costs are causing the contribution margin to be low. The company could try to lower the variable costs of the perfume by switching to a shipping company that charges less. Another thing the company could do to improve the imported perfume’s contribution margin is to increase the retail price.
When referring to revenue as a general term, this typically means revenue from all sources. Different types of revenue include sales revenue, revenue from investing activities such as interest earned or dividends paid on investments the company owns, revenue earned from the sale of corporate assets such as a property or piece of machinery and revenue earned from leasing activities such as leasing a property or machinery to another business.
Sales revenue from normal business activities is the most important of the revenue types because it is the main source of revenue. For example, a clothing company’s main source of revenue is through the sale of clothes. If it also carries a few accessory lines, the sale of the accessories makes the company revenue, but it isn’t as important as the revenue earned from the sale of clothes. To calculate revenue, the company multiplies the price of each product by the number of each product it sells. If a company sells multiple items, it would add the individual revenues from each product together to get total or gross revenue. Companies deduct the cost for customer returns and customer discounts from total revenue.
- Jupiterimages/Photos.com/Getty Images