Interpreting Contribution Margin
|Contribution Margin||What It Means||Manager Action|
|Large||The company is making a significant sum on each product and service it sells.||Managers may consider whether to reallocate resources to the products and services that offer the highest contribution margins.|
|Small||The company is profiting only a small amount on each product and service that it sells.||Managers may review ways to reduce costs or consider increasing the sales price to find ways to improve contribution margin.|
|Negative||The company is losing money every time it sells the product or provides a service.||Managers may decide to stop producing the product or providing the service and allocate those resources to a segment with a positive contribution margin.|
In summary, the contribution margin provides a company with a greater perspective on its profitability. It is key to note that when a contribution margin is negative, managers may decide to eliminate that segment and allocate resources to a segment with a positive contribution margin. However, companies may also consider lowering their costs to fix a negative contribution. This can be done by using cheaper raw materials, negotiating with vendors for lower raw materials prices, finding new vendors, or some combination of these.
The most important thing to remember about the contribution margin is: the higher the contribution margin is, the more profitable a company will likely be.The contribution approach is most helpful in determining a company's break-even point. The break-even point is the point at which a company's total revenue is equal to its total cost, which means zero profit and zero loss. For a nonprofit organization, "breaking even" is actually the ideal scenario. It is not an ideal scenario for for-profit companies, but it is better than incurring a loss.