Difference Between Gross Margin and Contribution Margin:
Learning Objectives:
- What is the difference between gross
margin and contribution margin?
Gross Margin is the Gross
Profit as a percentage of Net Sales. The calculation of the Gross Profit
is: Sales minus Cost of Goods Sold. The Cost
of Goods Sold consists of the fixed and variable product costs, but it
excludes all of the selling and administrative expenses.
Contribution Margin is Net Sales
minus the variable product costs and
the variable period expenses. The
Contribution Margin Ratio is
the Contribution Margin as a percentage of Net Sales.
Example:
Let’s illustrate the difference between
gross margin and contribution margin with the following
information: company had Net Sales of $600,000 during the past year.
Its inventory of goods was the same quantity at the beginning and at the end
of year. Its Cost of Goods Sold consisted of $120,000 of variable costs and
$200,000 of fixed costs. Its selling and administrative expenses were
$40,000 of variable and $150,000 of fixed expenses.
The company’s
Gross Margin is: Net Sales of $600,000
minus its Cost of Goods Sold of $320,000 ($120,000 + $200,000) for a Gross
Profit of $280,000 ($600,000 - $320,000). The Gross Margin or Gross Profit
Percentage is the Gross Profit of $280,000 divided by $600,000, or 46.7%.
The company’s
Contribution Margin is: Net Sales of
$600,000 minus the variable product costs of $120,000 and the variable
expenses of $40,000 for a Contribution Margin of $440,000. The Contribution
Margin Ratio is 73.3% ($440,000 divided by $600,000).
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