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What is a contribution margin?

Contribution margin is the selling price per unit of an item minus the variable cost per unit of that item. It’s the amount that is not used up on variable costs that you “contribute” to paying for the fixed costs of an item. This measure helps you as a business owner to know if a certain product you sell is profitable. The closer your contribution margin is to the actual selling price, the better, but be careful of overpricing, as that would affect the number of items you actually sell.

For example:

You have a business selling handmade children’s furniture. One type of chair you make sells for $25 each. Your variable costs for each chair (including things like paint, fabric, and wood), are $6. So your contribution margin is $19. You then use a portion of that money to pay the fixed costs (like the electricity bill in your workshop). On the other hand, if your fixed cost on this item is $19 each chair, then your contribution margin would only be $6. You might decide at this point that you need to up your selling price, or, if that’s not an option, consider if it’s worth producing.

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