Gross Margin vs. Contribution Margin: What’s the Difference?

Gross margin—also called gross profit margin, gross margin percentage, or gross profit percentage—is the percentage of a company's revenue that's greater than its cost of goods sold (COGS). This financial ratio demonstrates how effectively a business generates revenue compared to managing their production costs.

A business aims to have as high a gross margin as possible. A high gross margin indicates that a company is profiting more from product sales and has more cash flow to pay for indirect operating costs, hire additional labor, pay debt, or invest in growth for the future.

Contribution margin is a metric that shows the profitability of a specific product or product line produced by a company. The contribution margin is calculated by subtracting the total amount of variable costs of producing a particular product from that product's selling price. Variable expenses include costs related directly to sales output, such as raw materials and sales commissions.

Contribution margin is useful for calculating the number of units a company must sell before it becomes profitable or reaches its breakeven point. The metric can also be used to compare different products to determine the optimal production costs and price for profitability for each product in a line. Companies with high contribution margins will earn revenue faster and, in turn, become profitable faster.

Gross margin and contribution margin are both profitability metrics that exclude fixed expenses from their calculations, but there is one key difference between the two: gross margin shows the profitability of an entire business, while contribution margin shows the profitability of one individual product or product line produced by a company.

To calculate gross margin, subtract the cost of goods sold (COGS) from total sales revenue and divide that figure by the total sales revenue, as seen in the following equation:

Similar to the gross profit formula, revenue represents the total amount of money earned from product sales, and COGS represents the product production costs that fluctuate based on the amount of output.

To calculate contribution margin, subtract the total variable cost per product from the product's selling price, as seen in the following equation:

You can also calculate contribution margin as a ratio using the following formula:

1. 1. Gross profit: Gross profit is the amount of income left over after subtracting the cost of goods sold (COGS) from the total sales revenue. This metric indicates whether a company’s production process needs to be more or less cost-effective in comparison to its revenue.
2. 2. Net income: Calculate the net income metric by subtracting total expenses from total revenue to see exactly how much a company profits (a new profit) or loses (a net loss). A company's net income over time is a great indicator of how well or poorly its management team runs the company.
3. 3. Operating profit: To calculate operating profit or earnings before interest and taxes (EBIT), subtract operating expenses—which include overhead costs like rent, marketing, insurance, corporate salaries, and equipment—from gross profit. Investors find EBIT useful in determining a company's financial performance because it doesn't factor in items that are out of the management team's control.
4. 4. Gross profit margin: A gross profit margin is the percentage of revenue generated that's greater than the COGS. To calculate gross profit margin, divide gross income by revenue and multiply the result by 100.
5. 5. Contribution margin: Contribution margin measures the profitability of a single product or product line by subtracting variable costs of producing the product from its selling price.
6. 6. Net profit margin: Net profit margin is the ratio of net profit to total revenue expressed as a percentage. To calculate net profit margin, divide your net income by total revenue and multiply the answer by 100.

Get the MasterClass Annual Membership for exclusive access to video lessons taught by business luminaries, including Sara Blakely, Chris Voss, Robin Roberts, Bob Iger, Howard Schultz, Anna Wintour, and more.