contribution vs gross margin?
hey all - could someone help me understand the difference here? preferably with some # examples
my understanding is that gross margin = total revs - total direct costs (including fixed costs like salaries or manufacturing overhead that are not variable), whereas contribution margin is usually more on the product level and looks at product revs - variable costs directly associated with that product. thus, contribution margin excludes some fixed costs that are included in gross profit. therefore, contribution margin is usually higher than gross margin?
thanks in advance.
Gross to product could also take into account any discounts, loyalty programs, special offers, etc. Another example would be if you are talking about eCommerce, some retailers talk about revenue in terms of demand, and then back our cancels and returns. This helps their planning teams to better forecast the necessary supply to be available to customers, even if the product ultimately doesn’t make it to them.
From a PE perspective, contribution margin is calculated to better understand the operating leverage of a business as the business grows or as it shrinks.
Gross margin can be calculated directly from the P&L (revenue - COGs / revenue).
Contribution margin will take all direct costs associated with say winning a new customer. A number of these costs sit below the GM% line. For example, there may be additional charges for AWS provisioning. This usually requires having a discussion with the CFO to understand which costs are in fact variable vs fixed. Once contribution profit is calculated, the revenue change * contribution profit = change in EBITDA.
Thanks very much. Would you agree then that my understanding stated in my question above is accurate?
I think there is a nuance around describing “direct costs”. In PE the concept is very important for driving value during holding period so it’s a great way to understand the business via the P&L early.
It may be harder to that in IB if you don’t get to spend time with the CFO.
Said another way, we only cared about contribution profit and EBITDA margin in buyout as GM% wasn’t that useful.
Hey man.... circling back here.
is the following line item the same thing as "cash burn"?
"Net increase (decrease) in cash and cash equivalents: =($100)"
So for example, for company A, could you tell your MD that cash burn in 2020 was -$100?
What if there was a net increase of $100. You would say the company had NO cash burn?
Thanks a bunch in advance as always.
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