Contribution Analysis

Measures how much an individual product or the company, as a whole, has to contribute to the coverage of fixed costs and then profits

Author: Christy Grimste
Christy Grimste
Christy Grimste
Real Estate | Investment Property Sales

Christy currently works as a senior associate for EdR Trust, a publicly traded multi-family REIT. Prior to joining EdR Trust, Christy works for CBRE in investment property sales. Before completing her MBA and breaking into finance, Christy founded and education startup in which she actively pursued for seven years and works as an internal auditor for the U.S. Department of State and CIA.

Christy has a Bachelor of Arts from the University of Maryland and a Master of Business Administrations from the University of London.

Reviewed By: Osman Ahmed
Osman Ahmed
Osman Ahmed
Investment Banking | Private Equity

Osman started his career as an investment banking analyst at Thomas Weisel Partners where he spent just over two years before moving into a growth equity investing role at Scale Venture Partners, focused on technology. He's currently a VP at KCK Group, the private equity arm of a middle eastern family office. Osman has a generalist industry focus on lower middle market growth equity and buyout transactions.

Osman holds a Bachelor of Science in Computer Science from the University of Southern California and a Master of Business Administration with concentrations in Finance, Entrepreneurship, and Economics from the University of Chicago Booth School of Business.

Last Updated:October 13, 2023

What Is Contribution Analysis?

A contribution analysis, measures how much an individual product or the company, as a whole, has to contribute to the coverage of fixed costs and then profits. It’s the study and assessment of how direct and variable costs affect net income.

It is a relatively easy analysis done by management that can help analyze current product offerings and make decisions between future products. 

It is used to determine how changes in sales revenues and variable costs impact a company's net income, and it does this by measuring the profitability of individual products or product lines within a company. 

Thus, a contribution analysis can measure the direct impact of each product and then compare them to each other to make relevant decisions.  

There are many different uses of a contribution analysis, and it can be altered depending on a company's needs. 

Some of the ways it can be used are:

  • Develop statements on a unitary basis rather than comparing overall figures. 
  • Compare products or product lines by breaking down the contribution towards the coverage of fixed costs. 
  • Set selling prices with an ideal contribution. 
  • Compare or make changes to the selling price by comparing the contribution of each product. 
  • Make pricing decisions with certain target profits in consideration. 
  • Conduct further analysis (e.g., break-even) 

Key Takeaways

  • Contribution Analysis measures how products or the company contribute to covering fixed costs and profits, assessing the impact of direct and variable costs on net income.
  • It helps analyze product offerings, evaluate changes in sales revenues and variable costs, and compare individual product profitability for decision-making.
  • Contribution Analysis aids in setting selling prices, making pricing decisions, and determining target profits while considering cost breakdowns and cost allocations.
  • Contribution Margin and Contribution Margin Rate are essential metrics calculated to understand the financial impact of products on fixed costs and profitability.

Contribution analysis: Fixed vs. Variable Costs

To fully understand contribution analysis, you have to be aware of the different cost breakdowns or allocations a company uses.  This analysis works by allocating direct costs and variable costs and separating them from overhead, also known as fixed costs that are incurred throughout. 

Fixed Costs

Fixed costs are expenses that stay fixed and do not change with fluctuations in production. Fixed costs are not directly related to any product but are vital for a company's operations. Fixed costs under contribution analysis are considered to be non-inventoriable costs.

They aren't considered to be a part of the unit product cost. Rather, it's considered to be expensed during the period. Making it a period cost. They remain the same under absolute terms as the production varies. Changes under the per-unit basis. 

As production increases, per-unit fixed cost decreases and vice-versa.

Examples of fixed costs include: 

  • Rent 
  • Insurance 
  • Salaries 
  • Property tax 
  • Depreciation 

Variable Costs

Variable costs, on the other hand, are expenses that change with fluctuations in production. They are directly related to specific business activities. As production increases, variable costs increase. As production decreases, variable costs decrease. 

This means the variable costs are dependent on production. The total of variable costs is the product of variable cost per unit times the number of units budgeted or produced. The variable costs are constant on a per-unit basis. And varies in total.

Examples of variable costs include:  

  • Utilities 
  • Production supplies 
  • Raw materials 
  • Commissions/wages 

It's important to understand the cost breakdowns of a company, as it determines what an ideal contribution margin is. If a company has relatively low fixed costs, then a smaller contribution margin is alright. 

However, if a company has a significant amount of fixed costs, then a higher contribution margin is needed to ensure the profitability and survival of the company. 

Most companies tend to aim for a higher margin as fixed costs are considerable. It also means there is more money left to go towards earnings. 

Calculating contribution Margin

The analysis can be split up into Contribution Margin, also known as a Unit Contribution, which is the absolute dollar amount, and contribution margin rate, which is the percentage or ratio.

It can also be calculated on a per-unit basis by finding out the difference between the per-unit selling price and variable cost-per-unit. Contribution margin is calculated by subtracting variable costs from sales revenue, providing a measure of profitability for each unit sold.

There are two ways to calculate the contribution margin. The first way is to use revenue and total variable costs. 

Contribution Margin = Total Revenue (TR) - Total Variable Costs (TVC)

The second way, known as the unit contribution, is using the selling price and the variable cost per unit of that product. 

Unit Contribution = Selling Price (SP) - Variable Cost per Unit

Unit contribution can also be calculated using contribution margin if the number of units sold is known.  

Unit Contribution = Contribution Margin Number of units sold

While both produce different answers, they both reflect how much money is remaining that can go towards your fixed costs, whether as a total or from the sale of each unit. 

Contribution Margin Rate Formula: The contribution margin rate, expressed as a percentage, is the amount of revenue made from a product or the company that goes towards fixed costs and then earnings. 

Contribution Margin Rate = [(Total Revenue - Total Variable Costs)/ Total Revenue] * 100%


Contribution Margin Rate = [(Selling Price - Variable Cost per Unit)/ Selling Price] * 100% = Unit Contribution/ Selling Price * 100%

The Pros of Contribution Analysis

Contribution analysis constantly measures how much an individual product or the whole company has to contribute to the coverage of fixed costs and profits. Investors and Executives aim to gain valuable knowledge on the pros and cons of this metric to make assertive decisions. 

Some of the pros of using contribution analysis are:

1) Profitability Predictions

Contribution analysis provides a clear picture of which individual products, services, or business units contribute the most to the organization’s profitability. 

2) Smart Pricing Strategies

The cost structure and profitability of individual offerings aid organizations in setting appropriate pricing strategies. 

The products with a ‘Premium-Pricing’ lead to higher profits; hence, its value is justified. On the other hand, the lower margins of products, services, or business units may lead to cutting costs or incentivizing marketing efforts. 

3) Effective Resource Allocation

When companies understand the effectiveness of their products in a demand-supply model, they have better access to effective resource allocation. 

Examples can be allocating marketing budgets according to the contribution margins of a specific product or service, as it can be assigning R&D funds towards products or services with higher contribution margins to increase profits. 

4) Controlling the Cost

While businesses sometimes tend to go wild on tendencies or increases in demand, analysis of contribution margins helps control the cost of the offer smartly. This leads to more effective financial performance.

The Cons of Contribution Analysis

Opposite to the benefits mentioned, some cons of contribution analysis are:

1) Simplified View

Contribution analysis focuses on variable costs and contribution margins. It doesn’t consider other factors relevant to decision-making, such as long-term fixed costs, market dynamics, competitive positioning, or strategic considerations. 

2) Neglects Non-Financial Metrics

Contribution analysis may ignore non-financial factors that are essential for business success. 

For example, it may not consider customer satisfaction, brand reputation, or long-term growth potential, which can matter when building a sustainable business.

3) Limited Scope

The metric is useful for products or services with well-defined variables and fixed costs. It isn’t as applicable to industries with complex cost structures or those where fixed costs significantly influence overall profitability. 

4) Short-Term Focus

Contribution analysis has a short-term focus, as it deals with immediate costs and revenues. 

The long-term strategic goals of an organization should be addressed, which may require investments in products or services with lower short-term contribution margins but higher long-term potential.

5) Potential for Cost Cutting at the Expense of Quality

A general emphasis on contribution margin can lead to cost-cutting measures that compromise product or service quality, customer satisfaction, or employee morale. 

This can have negative long-term consequences when creating a sustainable business.

Further uses of contribution analysis

After conducting a contribution analysis, the contribution can also be used to conduct a break-even (BE) analysis. The break-even point is where the business does not earn a profit or a loss. This means that the company makes $0 and only makes enough money to cover its costs. 

Essentially, the company's revenues equal its expenses. 

A break-even analysis can be used to determine the number of units a business needs to sell to break even, the BE sales figure, and the target profit break-even. This can then be further used to calculate what percentage of the market you need to capture to break even during any given point. 

If the company sells multiple products, the contribution margin rate can further be used to calculate the Weighted Average Contribution Margin Rate. The Weighted Average Contribution Margin Rate is the average amount a group of products can contribute to the company’s fixed costs and then profit. 

Most companies would group together products that are similar or complementary. For instance, Charlotte Tilbury, a make-up company, could group together all their lip products and calculate the weighted average contribution margin rate. 

The Weighted Average Contribution Margin Rate, similar to the Contribution Margin Rate, can also be used to calculate break-even points. 

Contribution Analysis FAQs

Researched and authored by Pooja Patel | LinkedIn 

Uploaded and revised by Omair Reza Laskar | Linkedin

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