Contribution Margin (CM) is the difference between sales revenue and variable costs. It is the measure of the profit margin that focuses on the proportion of sales revenue which is left after the deduction of variable costs associated with the product.
Contribution is the amount which is left after subtracting variable costs from the revenues. This is the amount which is left to cover the fixed expenses of an organization, or to add to the profits of the organization.
Contribution margin is an important cost accounting concept. It is helpful in many making many important business decisions. For example, think of a situation in which a business manager determines that a particular product has a 25% contribution margin, which is below that of company's other products. The manager can use this figure to determine whether variable costs for that product need to be reduced, or if the price of the end product needs to be increased. If either of these options is not attractive, the manager may decide
to drop this unprofitable product in order to free resources to produce an alternate product with a higher contribution margin.
The contribution margin information can be used to add or remove products and product lines or to make informed pricing decisions.
Contribution margin can be calculated by using the following formula:
Contribution Margin = (Sale Revenue – Variable Costs) / Sales Revenue
The above formula calculates the contribution margin for all of the units sold. Contribution margin can also be calculated in a way very different from other types of margins. It can be calculated on a per unit basis with the help of following formula:
Contribution Margin per Unit = (Price per Unit – Variable Costs per Unit) / Price per Unit
In the case of contribution margin per unit, it can also refer to a per unit measure of a product's gross operating margin because it is calculated simply as the product's price minus its total variable costs.Source: www.readyratios.com