Contribution Margin definition, application with example

Contribution Margin

Contribution Margin is the amount which derive from excess of revenue after variable costs. 

The contribution Margin is calculated when management uses the marginal or variable costing approach :

Contribution Margin = (Sales - Variable Costs)

Here,
Variable Costs Contains = All production Variable Costs plus All variable selling and administration cost.

For Example :

Company A produce a final product x in 1,000 Units which selling price $5,  and variable cost per unit $2 and Fixed cost $200.

Contribution Margin :
(1000*5)- (1000*2)= $3,000

Noted: Fixed cost $200 is not considerable.

Now we are knowing why we can use Contribution margin followings :

1. To make the decision:
Contribution margin should be calculated in the context of managerial decision like ceasing product line or not so on.
2. For making Budget.
3. In CVP analysis.
4. In Variance analysis.

So, Contribution margin is very important in every aspect of decision making and managerial accounting.