contribution margin
Revenue minus variable costs, showing how much each unit sold contributes toward covering fixed costs and generating profit.
Example
“A product selling for $100 with $40 in variable costs has a $60 contribution margin — each unit adds $60 toward covering overhead.”
Memory Tip
CONTRIBUTION margin = what each sale CONTRIBUTES to covering fixed costs. Above break-even = profit.
Why It Matters
Understanding contribution margin helps you evaluate whether a business or product line is truly profitable after paying for the direct costs to produce it. This matters for personal finance because if you run a side business or freelance work, knowing your contribution margin tells you how much of each dollar earned actually helps cover your fixed expenses like rent or equipment.
Common Misconception
Many people confuse contribution margin with profit, thinking that if contribution margin is positive, the business is making money overall. However, contribution margin only tells you if a product covers its variable costs and contributes to fixed costs, not whether total fixed costs are actually covered or if the business is profitable.
In Practice
Imagine you sell handmade candles for 20 dollars each and spend 8 dollars on materials and packaging per candle. Your contribution margin is 12 dollars per candle. If you have 2000 dollars in monthly fixed costs like studio rent, you need to sell at least 167 candles monthly to break even, since 167 times 12 dollars equals 2004 dollars in contribution margin.
Etymology
CONTRIBUTION (what it adds) MARGIN (profit above variable cost). What each sale CONTRIBUTES toward fixed costs.
Common Misspellings
Small business accounting made simple
Related Terms
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See Also
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