Contribution margin ratio
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).
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:
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%
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.