Question

How is the contribution margin concept different from the gross profit concept and why is the distinction important? Why would a company endeavor to calculate these amounts for their products?

Answer 1

Gross profit margin measures the amount of revenue that remains after subtracting costs directly associated with production. Contribution margin is a measure of the profitability of various individual products.

Differences & Importance

The key difference between Contribution Margin and Gross margin is that Contribution margin is the difference between total sales by the company and its total variable cost which helps in measuring that how efficiently the company is handling its production and maintaining the low levels of the variable costs whereas Gross margin formula is used to know the financial health and the performance of the company and is calculated by dividing the gross profit.

Why would a company endeavor to calculate these amounts for their products?

Both these margins are important profitability ratios. The ratios allow us to make decisions to increase profit by analyzing different factors such as choosing the best product line to invest in, to analyze the marketing campaign which was most profitable, and optimization of the product price. Gross Margin indicates the profitability of the company, whereas contribution indicates profit contributed by each of the products of the company.