Define and explain the contribution margin. Include the difference in fixed and variable costs in your discussion.
Define and explain the contribution margin. Include the difference in fixed and variable costs in your discussion.
Contribution margin may be defined as the amount of profit generated when only the cost of goods sold is subtracted from the total revenue. The other expenses like selling and administration, finance costs, taxes etc are not deducted. As per the accounting principles followed, cost of goods sold include both the fixed and variable costs.
Variable costs may be understood as the costs which are directly proportional to the units produced for example in shirt manufacturing clothes, thread,buttons and the labor charges of the tailor are directly identifiable and related
Fixed Costs are those costs which remains fixed irrespective of the level of the units produced and has to be incurred by the business. Example include factory overheads like factory rent, supervisor\\\\\'s salary, factory security expenses, electricity, water etc.
We can understand this by following example. Say 1,000 units of product X is sproduced and old at $300 ech. Total total revenue is $300,000. The Direct material cost is $ 20 units each. Direct labor cost is $20 each.The fixed production overhead is $100,000.
So, the gross contribution can be computed as below
| Sales Revenue | $300,000 |
| Less: Cost of goods sold | |
| Direct material(1000 units* $20) | 20,000 |
| Direct labor (1000 units *$20) | 20,000 |
| Fixed production overhead | 100,000 |
| Gross Contribution | $160,000 |
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