Contribution margin ratio explained: Formula, examples and how it works for small businesses

Published Friday 5 December 2025

Table of contents

• What is the contribution margin ratio?
• How to calculate contribution margin ratio
• Contribution margin ratio examples
• Contribution margin vs gross profit
• Using contribution margin ratio for breakeven analysis
• How to improve your contribution margin ratio
• Track your contribution margin ratio with confidence
• FAQs on the contribution margin ratio

Key takeaways

• Calculate contribution margin ratio by subtracting variable costs from revenue and dividing by revenue to determine what percentage of each sale contributes to covering fixed costs and generating profit.

• Use contribution margin ratio to determine your break-even point by dividing total fixed costs by the contribution margin ratio, which shows the sales volume needed to cover all fixed expenses.

• Improve your contribution margin ratio by increasing prices when market conditions allow, negotiating better supplier rates to reduce variable costs, or focusing sales efforts on higher-margin products and services.

• Distinguish accurately between fixed and variable costs when calculating your ratio, as this precision directly impacts the reliability of your profitability analysis and strategic decision-making.

What is the contribution margin ratio?

Contribution margin ratio measures how much of each sale contributes to covering fixed costs and generating profit. This ratio helps you:

• Assess product profitability: identify which products generate the most profit per sale
• Calculate break-even points: determine sales volume needed to cover fixed costs
• Guide pricing decisions: understand how price changes affect profitability
• Evaluate cost structures: see how variable costs impact your bottom line
• Assess product profitability: identify which products generate the most profit per sale
• Calculate break-even points: determine sales volume needed to cover fixed costs
• Guide pricing decisions: understand how price changes affect profitability
• Evaluate cost structures: see how variable costs impact your bottom line

The ratio helps guide pricing decisions and cost structures – as outlined in this resource from Mass.gov – and is a useful way to assess how much revenue different products or services contribute to your bottom line.

How to calculate contribution margin ratio

Calculating your contribution margin ratio is a straightforward way to see how much of your revenue is available to cover fixed costs. This simple calculation helps you understand the profitability of each sale.

Contribution margin ratio formula

Contribution margin ratio formula:

(Revenue - Variable costs) ÷ Revenue = Contribution margin ratio

Step-by-step calculation:

1. Calculate contribution margin: $10 revenue - $5 variable costs = $5
2. Divide by revenue: $5 ÷ $10 = 0.50
3. Convert to percentage: 0.50 × 100 = 50%

This means 50% of each sale contributes to covering fixed costs and profit.

Contribution margin ratio examples

Let's look at a practical example to see how the contribution margin ratio works for a small business.

Imagine you run a coffee shop. You sell a latte for $5.00. The variable costs for each latte, including the cup, milk, and coffee beans, add up to $1.50.

• Revenue per unit: $5.00
• Variable cost per unit: $1.50

First, calculate the contribution margin per latte:

$5.00 (Revenue) - $1.50 (Variable Costs) = $3.50 (Contribution Margin)

Now, use the formula to find the contribution margin ratio:

$3.50 (Contribution Margin) / $5.00 (Revenue) = 0.70

Your contribution margin ratio is 70%. This tells you that for every $5.00 latte you sell, $3.50 is available to help pay for your fixed costs like rent, salaries, and utilities.

Contribution margin vs gross profit

Gross profit and contribution margin measure different aspects of profitability:

• Gross profit: revenue minus cost of goods sold (COGS)
• Contribution margin: revenue minus all variable costs (including COGS, marketing, and sales commissions)

Contribution margin provides a more complete picture of product profitability because it includes all variable expenses.

Contribution margin focuses on the costs and profitability of what you sell, and you can use this ratio to run break-even analysis or look at product-level profitability. Gross profit measures the overall financial health of the business, and the gross profit margin can help you make decisions about overall efficiency.

You can use contribution margin more effectively by looking closely at your income statement. Identify other variable costs that may not be immediately obvious, such as marketing expenses tied directly to a product or sales commissions.

According to Harvard Business Publishing, one of the trickiest parts of calculating contribution margin is accurately distinguishing between fixed and variable costs. The more precise you are in this step, the clearer your contribution margin and overall profitability will be.

Using contribution margin ratio for breakeven analysis

One of the most powerful uses of the contribution margin ratio is to calculate your breakeven point. This is the sales volume you need to reach to cover all your fixed costs, where your total profit is zero. Knowing this number helps you set realistic sales goals and make smarter financial plans.

To find your breakeven point in sales dollars, you use this formula:

Breakeven Point ($) = Total Fixed Costs / Contribution Margin Ratio

For example, if your coffee shop has total fixed costs of $7,000 per month and a contribution margin ratio of 70% (or 0.70), your breakeven point would be:

$7,000 / 0.70 = $10,000

This means you need to generate $10,000 in sales each month to cover your fixed costs. Any sales above this amount will start generating a profit.

How to improve your contribution margin ratio

Improving your contribution margin ratio directly boosts your profitability. In theory, it's simple: you either need to increase your revenue per sale or decrease your variable costs. Here are a few practical ways to do that.

Strategies to improve contribution margin ratio:

• Increase prices: monitor market conditions and competitor pricing to identify opportunities
• Reduce variable costs: negotiate better supplier rates, optimize production processes, minimize waste
• Improve product mix: focus on higher-margin products and services
• Enhance efficiency: invest in automation and technology to reduce labor costs per unit

Each 1% improvement in contribution margin ratio directly increases profitability.

Track your contribution margin ratio with confidence

Tracking your contribution margin ratio helps you make smarter business decisions and increase profitability. With Xero, you can easily monitor the key numbers that drive your success – helping you control costs, set better prices, and grow your bottom line. Support your business growth and get one month free.

FAQs on the contribution margin ratio

Here are answers to some common questions about the contribution margin ratio.

What's the difference between contribution margin and the contribution margin ratio?

Contribution margin vs contribution margin ratio:

Contribution margin = Dollar amount remaining after variable costs

• Example: $30 revenue - $20 variable costs = $10 contribution margin

Contribution margin ratio = Percentage of revenue remaining after variable costs

• Example: $10 contribution margin ÷ $30 revenue = 33% contribution margin ratio

The ratio helps you compare profitability across different products and sales volumes.

What is a healthy contribution margin ratio?

Industry benchmarks for contribution margin ratios:

• Software/SaaS: 70–90% (low variable costs)
• Retail: 20–40% (high product costs)
• Manufacturing: 25–50% (materials and labor)
• Food service: 60–70% (ingredients and packaging)

Aim for ratios above your industry average while considering your specific cost structure.

Is a 30% contribution margin good?

A 30% contribution margin means that for every dollar of sales, 30 cents is contributing to covering fixed costs and profit. While this might be low for some industries, it could be acceptable for businesses with very high sales volumes and low fixed costs, like a grocery store. Generally, you want this number to be as high as possible, but its quality is relative to your industry's standards.

How do I calculate the contribution margin ratio for multiple products?

To calculate the ratio for multiple products, you first need to determine the revenue and variable costs for each product individually. Then, apply the contribution margin ratio formula to each one. This allows you to compare the profitability of different items and identify which ones are your strongest performers.