Contribution Margin Ratio: Definition
The contribution margin ratio is the total contribution margin divided by total sales. It is also known as the profit-volume (P/V) ratio.
Contribution Margin Ratio: Explanation
The contribution margin is the amount of revenue in excess of variable costs. One way to express it is on a per-unit basis, such as standard price (SP) per unit less variable cost per unit.
The contribution margin may also be expressed 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
The contribution margin (or P/V) ratio is calculated as follows:
Company X manufactures and sells only one product. The per-unit costs are:
SP per unit = $30
VC per unit = $18
Contribution margin per unit = $12
The company reports fixed costs of $40,000.
Required: Calculate the contribution margin ratio (or P/V ratio).
P/V ratio = 30 – 18/30 = 40%
A contribution margin ratio of 40% means that 40% of the revenue earned by Company X is available for the recovery of fixed costs and to contribute to profit. The remaining 60% is consumed by variable costs.
The break-even point (BEP) is calculated using the contribution margin ratio. The formula is:
BEP = Fixed costs / P/V ratio
= 40,000 / 40%
Conceptually, the contribution margin ratio reveals essential information about a manager’s ability to control costs. This is especially true in relation to sales revenue.
A firm’s ability to make profits is also revealed by the P/V ratio. With a high contribution margin ratio, a firm makes greater profits when sales increase and more losses when sales decrease compared to a firm with a low ratio.
We hope this article has helped improve your understanding of the contribution margin ratio. Learn more about it when you get in touch with a financial advisor in Clayton, MO. If you live outside the area, check out our financial advisor page.