Here is a nice quick video to help you understand better about the topic:-
Contribution margin is a cost accounting concept that allows a company to determine the profitability of individual products. The phrase “contribution margin” can also refer to a per unit measure of a product’s gross operating margin calculated simply as the product’s price minus its total variable costs.
To determine the contribution margin, subtract all variable costs of a product from its revenues, and divide by its net revenue. Product variable costs typically include, at a minimum, the costs of direct materials and sales commissions. The calculation is:
(Net product revenue – Product variable costs) ÷ Product revenue
For example, the Iverson Drum Company sells drum sets to high schools. In the most recent period, it sold $1,000,000 of drum sets that had related variable costs of $400,000. Iverson had $660,000 of fixed costs during the period, resulting in a loss of $60,000.
| Revenue | $1,000,000 |
| Variable expenses | 400,000 |
| Contribution margin | 600,000 |
| Fixed expenses | 660,000 |
| Net loss | ($60,000) |
Iverson’s contribution margin is 60%, so if it wants to break even, it needs to either reduce its fixed expenses by $60,000 or increase its sales by $100,000 (calculated as $60,000 loss divided by 60% contribution margin).