Reasons Your Business Can’t Ignore Its Contribution Margin
Responsible business owners recognize the importance of keeping track of their performance. There is no shortage of metrics used when evaluating the financial health of a company, from units sold to profits to reinvestment, and more. For every story you want to tell about the economic performance of your business, there are multiple metrics to consider.
Often, business owners will focus only on a few key metrics that are important and specific to them. Consequently, this concentration can be detrimental to the company, and overlooking other valuable metrics is dangerous. A critical example is the contribution margin. Too many leaders are ignoring the importance of their contribution margin, or, worse, don’t even know what the contribution margin is or what it measures.
Do you know what a contribution margin measures or why it’s important? Read on to find out.
Defining the Contribution Margin
The contribution margin of a business is measured as the revenue of a business minus the variable portions of that business’s costs. The variable expenses are those that change based on the amount of output, such as increased materials, higher storage space needed, more shipping costs, increased travel required, etc. Variable costs go up when more production is needed and down when there’s less. Everything else is a fixed charge, such as one-time purchases of equipment or machines.
The contribution margin is simply the total sales revenue, in dollars, minus the total variable costs, in dollars. Expressed this way, the contribution margin expresses the amount of revenue that is free to be put towards fixed costs and business reinvestment in the future. Another common way to express contribution margin is as a percentage or ratio, dividing that dollar value of sales revenue minus variable costs by the sales revenue.
Why is Contribution Margin Important?
When evaluating the health of a business, the contribution margin will first indicate what the breakeven point is. If the sales revenue is exceeded by the variable costs, there is no money to be made. If the sales revenue equals the variable costs, there is no additional money to help the business grow. But if the sales revenue well exceeds the variable costs, then there are plenty of benefits for the business owner to help their organization flourish.
In the hands of the experts, such as Tobin & Collins, the contribution margin can uncover what the selling price range of a product should be, what expected profits could be as the business grows, and how employees, current and future, can be fairly and sustainably compensated for their contributions to the business.
Measuring your company’s performance metrics, like contribution margins, can be hard to track and confusing to follow up on. If you want an expert evaluation of your business’ financial performance, we can help. The pros at Tobin & Collins can help walk you through your contribution margin and any other relevant metrics. Contact Tobin & Collins to learn more.