Contribution Margin vs Gross Margin

Difference Between Contribution Margin vs Gross Margin

The gross margin determines the costs which are associated with the only manufacturer of the product. It is an important tool to detect the raw material costs for a company in comparison with the competitors. Whereas contribution margin relates to the analysis of the product part by part such as all the variable costs part by part within an individual product. The contribution margin determines the margin at several stages of production where only variable costs are involved such as packaging costs, marketing, and distribution costs.

Let us study much more about Contribution Margin vs Gross Margin in detail:

Costs and expenses are associated with a Business. The costs can be further classified as variable costs and Fixed costs. Costs that are compulsory and cannot reduce and do not depend upon the quantity of the product are known as Fined costs. For example expenses like Rent, Building, depreciation, Salaries, etc. which are associated with a factory are fixed, no matter how much production a particular company is doing. On the other hand, there are certain costs that depend on the number of units produced by the company and can be nil in case of zero units produced.

Gross Margin:

Gross Margin is calculated as follows:

Gross Profit / Sales *100

In other words, Gross profit as a percentage term to Sales. It is required to detect the material costing required to manufacture a product. Manufacturing expenses including direct costs like Raw material costing cost of packaging and wages. Thus Sales minus the Direct Raw material costs are calculated. The profit which we get is the Gross profit.

Contribution Margin:

The contribution margin is calculated after deducting variable expenses required for the product and variable period expenses. The profit which we get after these variable expenses are met and the percentage of the contribution profit in terms of sales.

Contribution margin = Sales – (variable costs and variable expenses) / total sales*100

Example with an illustration:

The income statement of NOCIL Ltd. for the year ended 31/03/18 (INR in Cr):

Additional information:

• ‘Cost of materials’ includes 60% of fixed expenses and 40% of the variable part.
• Within ‘Other expenses’ 25% is included as marketing and packaging expenses which is entirely variable.

From the above financial data, we can derive the Contribution and Gross margin as follows.

Gross margin = (Total Revenue – Cost of goods sold)/total sales * 100

= (982.19-444.19 /982.19)*100 = (538/982.19) = 54.78% and

Contribution margin = (Total Revenue – Total Variable costs)/total sales * 100

**As we know that 25% of COGS and 40% of ‘Other costs’ are variable.

Thus Contribution Margin = 982.19 – (25% of 444.19) + (40*190.43) / 982.19 *100

= 982.19- (111.05 + 76.17) /982.19 *100 =982.19- 187.22 /982.19 *100

= 80.94%

Thus from the above, the Gross margin and the Contribution margin are derived as 54.78% and 80.94% respectively.

Importance of Contribution margin vs Gross Margin is as follows:

• One of the major importance of Contribution margin vs the Gross margin is to detect the variable costs and as well the percentage of fixed costs included within the margin. In case of any shut down of production plants, these are the powerful tools that could help to detect the management of the future strategies.
• In case there has been a loss of market share of a particular product, the higher the fixed costs, the higher would be the expenses resulting in lower profitability and margins.
• These are the strongest tools that are necessary for the companies whose strategy is to play in the volume growth of the products. Volume growth means adding in the number of products. The more the number of products is sold, the more is the profit. And at one point the break-even point arrived and there is margin expansion. The break-even point is determined by the amount of fixed cost associated with the Cost of Goods sold and within the ‘Other Expenses’. Again Depreciation and Employee expenses are also a part of fixed costs.
•  Variable costs are present within the COGS, and as well as with the packaging costs, marketing, and distribution costs. This contribution margin determines the margin at several stages of production where only variable costs are involved. Thus it helps the management for cost optimization, costs efficiency, and reduction of costs to enhance profitability.
• One company may have several products and the margins related to each product are different. Thus to enhance profitability and margins the company has to push those ‘high margin’ products which would add added margin to the Net Profit margin. Thus to get an accurate view and the importance of each product, the contribution margin becomes helpful.

Contribution Margin vs Gross Margin (Infographics)

Below is the top 3 difference between Contribution Margin vs Gross Margin:

Key Differences Contribution Margin vs Gross Margin

Both Contribution Margin vs Gross Margin are popular choices in the market; let us discuss some of the major Difference Between Contribution Margin vs Gross Margin:

• Gross margin, on the other hand, deals with the overall manufacturing and labor costs involved in the process of making a particular product. It includes both variable and as well as fixed expenses also. The contribution margin deals with the variable costs only.
• In the case of outsourcing or information Technologies companies, the entire employee costs are taken within COGS as the employee expenses are the COGS. Whereas in the case of other manufacturing company’s employee expenses are not included within Gross Margin, it comes within the Operating expenses. Costs like manufacturing, packaging costs, logistics costs, freight, commissions, wages, etc fall into the Contribution margin category.
• Well, in the case of Contribution margin and Gross margin, the types of expenses which are taken are mostly variable expenses in case of gross margin and Mixture of variable and fixed in case of contribution costs.

Contribution Margin vs Gross Margin Comparison Table

Let’s have a look at the Comparison between Contribution Margin vs Gross Margin:

Conclusion

Both the Contribution Margin vs Gross Margin helps in determine profitability and the cost-effectiveness for the company. The management takes this margin seriously to combat the business cycle so that the margins remain impact and so as the profitability. In case of economic down torn the management would emphasize retaining the top-line and pushing of high margin products so that the bottom-line remains intact. In case of a severe recession, the management might work on volume growth and through different cost-cutting techniques, the margin has to maintain.

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