Another method used in CVP analysis is contribution margin technique.

Let's start with the definition of contribution margin.

Contribution margin (contribution) is the difference between sales and variable costs (expenses). Contribution contributes toward fixed cost and profits. Contribution margin may be calculated in total or per unit.

The calculation of contribution margin in total is as follows:

Contribution = Sales - Variable Costs

The calculation of contribution margin per unit is similar to the contribution calculation in total, except that all amounts are divided by the number of units:

For example, assume the following data are planned for Friends Corporation for the next year:

Contribution margin is calculated using the earlier formula:

Contribution = Sales - Variable Costs = $75,000 - $45,000 = $30,000

Contribution is $30,000, which is the amount remaining after variable costs to contribute towards (cover) fixed costs and profits.

The contribution margin per unit can be determined as shown below:

This $2 per valve contributes toward (covers) fixed costs and profits.

Contribution margin ratio is the contribution margin divided by the sales amount. It is the percent of sales dollars available to cover fixed costs. Once fixed costs are covered, the next dollar of sales results in the company's profit. Contribution margin ratio is expressed as a percent.

Based on the figures from the Friends Corporation managerial accounting, contribution margin ratio will comprise:

The 40% calculated above means that fixed costs and profit represent 40% of total sales (because contribution margin is fixed costs plus profit, or sales less variable costs).