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← Investopedia Video: Contribution Margin

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Showing Revision 17 created 02/19/2019 by Alexandre Clemente.

  1. Contribution margin is the difference
    between sales revenue and variable cost.

  2. it allows a company
    to determine the profitability
  3. of individual products by
    measuring how sales affect profits.
  4. In its ratio form, it is calculated
    as contribution margin
  5. divided by sales revenue.
  6. While revenue from a company's product
  7. is how much money the company makes from selling that item,
  8. a product's variable costs include those expenses
  9. that vary depending on the company's production volume.
  10. A business owner, Ida might
    use contribution margin figures
  11. to decide which
    products costs,
  12. he should reduce or
    which price he should increase.
  13. For example,
    if a pair of jeans sells for $100,
  14. and its variable costs are $65,
    its contribution margin is $35 or 35%.
  15. This means that for each dollar
    of sales, profit increases by 35 cents.
  16. Ida wants to see a
    contribution margin ratio of 50%.
  17. He determines
    he can achieve this
  18. either by reducing
    variable cost to $50
  19. by increasing the price
    of jeans to $130,
  20. or through some
    combination of the two.
  21. Another option is to quit
    selling jeans entirely,
  22. and focus on other products
    such as button-down shirts,
  23. which already have a
    contribution margin of at least 50%.
  24. Ida might also want to
    calculate the contribution margin
  25. for all of his
    products in sum.
  26. If total variable costs re $750,000,
    and total sales are 1.5 million dollars,
  27. the total contribution margin
    in ratio form will be 50%.
  28. The business could compare
    the contribution margins
  29. of individual products against
    the company's total contribution margin
  30. to determine which products to sell
    more of, or which to sell less off.
  31. If dress slacks have a
    contribution margin of 60%,
  32. and it is possible
    to sell more of them
  33. at the same price total
    contribution margin will rise.