A company’s contribution margin equals its sales revenue minus its variable costs and is the amount of money available to pay its fixed expenses and contribute to profits. Fixed expenses remain the same regardless of a company’s sales. Once your company’s sales cover your fixed expenses, the remaining money is profit. Overall contribution margin ratio equals a company’s contribution margin divided by its sales revenue. This ratio shows the contribution margin as a percentage of each dollar of sales. A higher contribution margin ratio means each dollar of sales helps pay down fixed expenses faster, which can lead to higher profits.
Determine your company’s sales for an accounting period. For example, assume your company generated $100,000 in sales in the past year.
Determine your company’s variable expenses for the accounting period. In this example, assume your company incurred $35,000 in variable expenses during the past year.
Subtract the amount of variable expenses from sales to calculate the contribution margin. In this example, subtract $35,000 from $100,000 to get a $65,000 contribution margin.
Divide the contribution margin by the amount of sales to calculate the contribution margin ratio. In this example, divide the $65,000 contribution margin by $100,000 in sales to get 0.65, or 65 percent. This means that 65 cents of every dollar of sales your company generates contribute toward fixed expenses and profit.
You can multiply your contribution margin ratio by an expected increase in sales to calculate the amount of the increase that will contribute to your fixed expenses and profit. For example, if you expect a $5,000 increase in sales, multiply 0.65 by $5,000 to get $3,250, which is the amount that will go toward fixed expenses and profit.