# What is Contribution Margin Ratio?

In managerial accounting, contribution margin ratio (CM ratio) is a measure that helps a company determine how much of its revenue is available to cover fixed costs and contribute to net income. It is a useful tool for making decisions related to pricing, product mix, and other business strategies. This blog post will explain what contribution margin ratio is and how it can be calculated and used.

What is Contribution Margin Ratio?

Contribution margin ratio is the percentage of sales revenue that is available to cover fixed costs and contribute to net income after accounting for variable costs. In other words, it is the amount of money that remains from each dollar of sales after accounting for the variable costs of producing and selling the product. The contribution margin ratio is calculated by dividing the contribution margin by the total sales revenue.

Formula for Contribution Margin Ratio:

Contribution Margin Ratio = (Sales – Variable Costs) / Sales

The contribution margin is calculated by subtracting the variable costs from the total sales revenue. The variable costs are costs that vary with the level of production, such as the cost of raw materials, direct labor, and commissions on sales. Fixed costs, on the other hand, are costs that do not vary with the level of production, such as rent, salaries, and insurance.

Importance of Contribution Margin Ratio:

Contribution margin ratio is an important metric in managerial accounting because it helps businesses make decisions related to pricing, product mix, and other business strategies. By understanding how much of each dollar of sales is available to cover fixed costs, businesses can determine how much they need to sell in order to break even and how much they need to sell in order to make a profit.

For example, if a business has a contribution margin ratio of 40%, it means that 40 cents of each dollar of sales are available to cover fixed costs and contribute to net income. If the business has fixed costs of \$100,000 per month, it would need to generate \$250,000 in sales per month in order to break even (\$100,000 divided by 40%). If the business wanted to generate a net income of \$50,000 per month, it would need to generate \$375,000 in sales per month (\$100,000 fixed costs plus \$50,000 net income divided by 40%).

By calculating the contribution margin ratio for each product or service that a business offers, it can determine which products or services are the most profitable and which ones may need to be discontinued or re-priced.

Contribution margin ratio is an important metric in managerial accounting that helps businesses understand how much of each dollar of sales is available to cover fixed costs and contribute to net income. By calculating the contribution margin ratio for each product or service, businesses can make informed decisions about pricing, product mix, and other business strategies.

Caroline Grimm

Caroline Grimm is an accounting educator and a small business enthusiast. She holds Masters and Bachelor degrees in Business Administration. She is the author of 13 books and the creator of Accounting How To YouTube channel and blog. For more information visit: https://accountinghowto.com/about/