Contribution margin ratio

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on June 22, 2021

Definition of Contribution Margin Ratio

The total contribution margin divided by the total sales is equal to Contribution margin ratio. It is also known as the profit-volume ratio (p/v ratio).

Explanation

The Contribution Margin, as we know, is the amount of revenue in excess of variable costs. Contribution margin may be expressed on per unit basis (S.P. per unit – variable cost per unit) or in total dollars (Sales Revenue – Total variable costs), or as a percentage of sales. When the contribution margin is expressed as a percentage of sales, it is called the contribution margin ratio or profit-volume ratio (P/V ratio).

Formula to calculate Contribution margin ratio or P/V ratio

The Contribution margin or P/ V ratio is calculated as follows:
Contribution Margin Ratio Formula

Example

Suppose, A Company X manufactures and sells a single product. The per unit costs are as under:
S.P. per unit = $30
V.C. per unit = $18
Contribution margin per unit = $12
The company shows fixed costs of $40,000. Calculate the Contribution margin ratio or P/ V ratio.
P/V ratio = 30 – 18/30 = 40%
A contribution margin ratio of 40 percent means that 40 percent of the revenue earned by Company X is available towards the recovery of fixed costs and to contribute towards profits. The remaining 60 percent is consumed by variable costs.
The Break-Even point can also be calculated with the help of the Contribution margin ratio or P/ V ratio.
B.E Point = Fixed Costs / P/V Ratio
= 40,000 / 40%
= $100,000
Conceptually the Contribution margin ratio or P/ V ratio reveals more about a managers ability to control costs, especially in relation to sales revenue. The firm’s ability to make profits is also revealed by this ratio. With a high Contribution margin ratio or  P/ V ratio a firm makes greater profits when sales increase and more losses when sales decrease than a firm with a low Contribution margin ratio.

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