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17/11/2017 09:15:53 PM

Contribution Margin Versus Gross Margin

Gross  margin=Revenues-Cost of goods sold

Contribution  margin=Revenues-All variable costs

Gross margin measures how much a company can charge for its products over and above the cost of acquiring or producing them. Companies, such as branded pharmaceuticals, have high gross margins because their products provide unique and distinctive benefits to consumers. Products such as televisions that operate in competitive markets have low gross margins. Contribution margin indicates how much of a company’s revenues are available to cover fixed costs. It helps in assessing risk of loss. Risk of loss is low (high) if, when sales are low, contribution margin exceeds (is less than) fixed costs. Gross margin and contribution margin are related but give different insights. For example, a company operating in a competitive market with a low gross margin will have a low risk of loss if its fixed costs are small.

Consider the distinction between gross margin and contribution margin in the context of manufacturing companies. In the manufacturing sector, contribution margin and gross margin differ in two respects: fixed manufacturing costs and variable nonmanufacturing costs. The following example (figures assumed) illustrates this difference:

Contribution income statement emphasizing contribution margin

Revenues

 

$1,000

Variable manufacturing costs

$250

 

Variable selling and administrative

270

520

Contribution margin

 

480

Fixed manufacturing costs

160

 

Fixed nonmanufacturing costs

138

298

Operating income

 

$182

Finacial accounting income statement emphasizing Gross margin

Revenues

$1,000

Cost of goods sold ($250 + $160)

410

Gross margin

590

Selling and administrative expenses (270 + 138)

408

Operating income

$182

 

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