What it measures
Variable costs change with volume. Typical examples are materials, packaging, sales commissions, card processing fees and the direct labour tied to each job. Fixed costs, such as rent, insurance and salaried office staff, generally stay the same whether you sell a little or a lot.
Contribution margin sets sales against only the variable costs. Each sale adds a fixed amount of contribution, and once the total covers your fixed costs the remainder is profit. That makes it a practical tool for pricing, for judging a discount and for deciding which products or services deserve effort.
A worked example
For illustration, suppose a bakery sells a custom cake for $50. Ingredients, packaging and card fees for that cake total $30. The contribution margin is $20 per cake, and the contribution margin ratio is $20 divided by $50, or 40%.
If the bakery sells 400 cakes in a month, total contribution is $8,000. If fixed costs for the month are $6,000, about $2,000 is left as profit before income tax. Selling 300 cakes would cover the fixed costs exactly, which is where the break-even point sits. The numbers are round and illustrative only.
How it differs from gross margin
Gross margin deducts the cost of goods sold, and what is included there depends on how the business classifies its costs. A manufacturer may include some fixed production overhead, and a service business may treat all delivery labour as direct even when it is paid a fixed salary. Contribution margin sorts costs by behaviour instead: does the cost move when volume moves?
Many costs are mixed. A phone plan with a base fee plus usage, or an hourly worker with a guaranteed minimum, is partly fixed and partly variable. Splitting these takes judgment, so keep the method consistent from period to period.
What to discuss with your accountant
Ask which costs in your books behave as variable and whether your chart of accounts lets you report them separately. Use sales figures before GST/HST, since the tax you collect is not your revenue. Ask how contribution margin compares across products, clients or locations, and how a price change or a new hire would move it.
Pair it with your fixed costs to find the break-even point, and with the income statement to see what is left after overhead.
Sources & editorial notes
Sources checked October 24, 2026. The examples are illustrative and provide general information. Discuss how the guidance applies to your circumstances with your accountant.
Rules and guidance can change. Use the current official source and confirm the treatment for your facts. To flag an error, contact Sora.