Question

The Concepts Of Gross Margin And Contribution Margins Are Two Important Measures Companies ... Your question has been answered Let us know if you got a helpful answer. Rate this answer Question: The concepts of gross margin and contribution margins are two important measures companies can us... The concepts of gross margin and contribution margins are two important measures companies can use to determine how well they are faring in terms of profit-making. While gross margin is simply revenue less the total cost of the goods sold, contribution margin is revenue, less variable costs. According to Datar and Rajan (2018), “the 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 brand-name pharmaceuticals producers, have high gross margins because their products are often patented and provide unique and distinctive benefits to consumers. In contrast, manufacturers of generic medicines and basic chemicals have low gross margins because the market for these products is highly competitive. Contribution margin indicates how much of a company's revenues are available to cover fixed costs. It helps in assessing the risk of losses. For example, the risk of loss is low if the contribution margin exceeds a company’s fixed costs even when sales are low. Gross margin and contribution margin are related but gives 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.” What other insights or observations do you have with regard to gross margin and contribution margin? Do those insights change depending on the industry sector being considered; if so, why?

Answer 1

Insights on Gross Margin and Contribution Margin

Gross Margin

Definition: -

Gross Margin is revenue deducted by cost of goods sold. The cost of Goods sold includes any cost which are related to the production which are the fixed cost of production and variable cost of production. The Gross margin does not include any other administrative expenses like wages rent .

To calculate the overall profitability of the company Gross Margin is a very important aspect.

Contribution Margin

Definition :-

Contribution Margin means the Selling Price of the product deducted by the variable cost of the product. Contribution Margin helps in deciding the individual profitability of the product. Contribution Margin takes in to account only the variable portion of production costs and no fixed costs are taken into consideration.

Pricing

Gross Margin is used as an indicator to determine weather the sales prices are profitable to cover the total cost of production or not.

Contribution Margin on the other hand helps in determining the correct pricing decision as low or negative contribution margin shows a low product line.

Formula

Gross margin: -

Revenue                                                          xxxx

(less)                    

COGS                                                                 (xxxx)

                                            

Contribution Margin

Formula

Sales :                                                               XXXX

(less)                                                  

Variable Cost                                                  (XXXX)

Contribution Margin                                     XXXX