Contribution Margin in Retail
The difference between total sales revenue and total variable costs. The term is can be applied to a product or product lines and is generally expressed as a percentage.
Contribution Margin = Sales - Variable Costs
In retail, the Gross Margin Percent is recognized as the Contribution Margin Percent. The contribution margin information can be used to add or remove products and product lines or to make informed pricing decisions.
For example, After subtracting our total variable costs from our sales, we found our annual contribution margin was 42%. In other words, for each dollar of sales, 42 cents was left to contribute toward direct costs and profit.
The key to contribution margin versus gross margin is in the method used to calculate it. In this scenario, you only subtract variable costs. These variable costs could include selling expenses, freight, admin costs etc, but not fixed costs such as rent. Gross profit, on the other hand, is figured by subtracting cost of goods sold (COGS) from sales. Because cost of goods sold usually includes a mixture of fixed and variable costs, gross profit is not equal to contribution margin. It is a separate look at your results measuring for a different component.
Typically, you can use contribution market to calculate a view of your retail business in three ways.
- As a Total
- By Unit
- As a Ratio
Essentially the value of contribution margin is to examine the ways different parts of your business interact and affect each other such as total sales, sales prices, fixed costs, variable expenses, etc. As a Total, you are monitoring the amount of contribution earned by the store as a whole. Obviously, different product lines will have different contributing margins. Some will contribute more margin to the bottom line than others.
Your total sales, costs and margins all work in proportion with each other versus your fixed costs which remain the same regardless of how high your margins are or what your sales gain is year over year. What you sell an item for can impact your margin and profit, but it does not change the rent.
As a retailer, though, the contributing margin calculation is not as relevant as other margin and profit calculations. This view and equation is more helpful to a manufacturer than a retailer. While a retailer wants to know which products might be generating (contributing ) the most profit, the reality is that there are few variable costs. The variable costs come from the materials used to manufacture the product. So, take a shoe for example. One shoe might be made of leather from a cow and another one from manmade materials.
The cost to assemble is the same, but the cost of the material is greatly different. Using this snapshot helps a manufacturer determine if they should change materials in production. But as a retailer, the shoe costs $50 regardless if the material. It is the cost the vendor is charging the retail store.
Bottom line (to use a pun) there are other calculations that are more important for you as a retailer. There are many others you should look at on a regular basis that will determine your success much better than contributing margin. You need to become familiar with how to calculate them and how to read them on your finically statements each month. Here are some links to articles to help you learn more about them and how they will help you.