Gross profit margin is a measure of the total amount of revenue a business has made after deduction of fixed costs that are directly associated with production. Therefore, it indicates the price difference that produced goods or services are sold above their fixed cost of production or acquisition. Such fixed costs include building rent, insurance, and property tax. The contribution profit margin is used to assess variable production costs. The variable costs include fluctuating expenses such as raw materials, labor, and electricity. Contribution profit margin can also be thought as the portion of sales that offsets fixed costs. The contribution profit margin is calculated as the difference between variable costs and revenue generated and then dividing the result by the revenue generated ( Horngren , 2019) .
Both profit margins have internal and external use by management. They offer managers valuable but diverse information. The contribution profit margin is not a general measure of the business’s profitability but it can be used to calculate the profitability of individual items and offering for improvement through reducing variable costs or increasing the item’s price. Since the market will not accept an inferior product or an overpriced one, contribution profit can be adjusted by combining the techniques and producing slightly inferior products at a relatively higher price. Since gross profit margin is a standard metric in financial statements, it is always calculated the same way and gives a group picture of all products and their profitability. Low gross profit margin reduces the risk of loss when fixed costs are low. The contribution profit margin gives the percentage of profitability provided by a particular item. The company can use this information to decide if to continue its production or replace it with an item with greater profitability.
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References
Horngren, C. T., Datar, S. M., Rajan, M. V., & Beaubien, L. (2019). Horngren's cost accounting: A managerial emphasis .
