Contribution margin vs gross margin. This is a matter of great confusion among many accounting students. Most of them think they both are the same.
In this post, we are going to explain what both terms actually mean and what makes contribution margin different from gross margin.
The Concept of Gross Margin
Gross margin is calculated as the difference between the revenue and cost whereas contribution margin is the difference between revenue and cost plus sales expenses.
Gross margin is one of the most important and useful metrics in accounting for profitability. It is commonly used by businesses to understand and determine how profitable their business is. The difference between gross margin and contribution margin is that gross margin measures profit that is not directly related to the business.
The Concept of the Contribution Margin
Contributory margin is defined as the difference between the cost of goods sold and revenue. It is a measure of profitability. In cost accounting, it is computed by dividing the value of the cost of goods sold by the value of total sales. If the cost of goods sold =$100 and total sales =$150 the contribution margin would be $50.
Contribution margin is a measure of profitability that considers both sales and expenses. A company that has a low gross margin and high contribution margin is profitable but it is not necessarily a profitable business. Gross margin and contribution margin do not necessarily have the same meaning.
Gross Margin vs Contribution Margin
- One point of difference between gross margin and contribution margin is that contribution margin is the sum of gross margin and fixed costs.
- GM will appear in absorption costing income statement, while the contribution margin will appear in variable costing income statement. Contribution margin sometimes provides a better picture of profitability rather than gross margin.
- Formula of gross margin is revenue less total manufacturing costs. Formula for contribution margin is revenue less all variable costs [Sales – variable costs].
- Gross margin is useful for financial reporting purpose while contribution margin serves the purpose of internal cost reporting purpose. It has nothing to do with statutory reporting requirements.
- Gross margin is used to measure the overall economic performance of a business. On the other hand, contribution margin is used to measure the economic performance of a part of a business and hence, it is used to calculate the profit.
It can be seen that both types of margins have their respective use according to the accounting department.
Gross margin refers to the profitability of an entire business. It also includes the expenses for selling and marketing. It is the amount of money obtained from all the sales made by the business minus all its costs. It is calculated as the total revenue minus the total cost of sales.
On the other hand, contribution margin refers to the profitability of a part of a business and hence, it is used to calculate the profit. It is the amount of money obtained from the sales made by the business minus the sales expenses. It is calculated as the sales revenue minus the sales expenses.