The contribution margin ratio is computed by:
A) dividing the variable cost per unit by the sales revenue per unit..
B) subtracting the variable cost per unit from the sales price per unit.
C) dividing the sales revenue per unit by variable cost per unit.
D) dividing contribution margin per unit by the sales price per unit.
The correct answer and explanation is :
The correct answer is D) dividing contribution margin per unit by the sales price per unit.
Explanation:
The contribution margin ratio is an important financial metric used to assess how much a company’s sales revenue is contributing to covering fixed costs and generating profits. It represents the proportion of each sales dollar that contributes to covering fixed costs and generating profit after accounting for variable costs.
The contribution margin itself is calculated as:
[
\text{Contribution Margin per unit} = \text{Sales Revenue per unit} – \text{Variable Costs per unit}
]
This amount represents the portion of each unit sold that is available to cover fixed costs and, once fixed costs are covered, to contribute to profit.
The contribution margin ratio is a percentage that expresses how much of each sales dollar is available to cover fixed costs and contribute to profit. To calculate the contribution margin ratio, we divide the contribution margin per unit by the sales price per unit:
[
\text{Contribution Margin Ratio} = \frac{\text{Contribution Margin per unit}}{\text{Sales Price per unit}}
]
This ratio shows what percentage of sales revenue is left after covering the variable costs. For example, if a company has a sales price of $100 per unit and a variable cost of $60 per unit, the contribution margin per unit would be:
[
\text{Contribution Margin per unit} = 100 – 60 = 40
]
Then, the contribution margin ratio would be:
[
\text{Contribution Margin Ratio} = \frac{40}{100} = 0.4 \text{ or 40\%}
]
This means that 40% of each dollar of sales contributes to covering fixed costs and generating profit.
Why other options are incorrect:
- A) This would calculate a ratio of variable cost per unit to sales price, which is not the contribution margin ratio.
- B) Subtracting variable costs from sales price gives the contribution margin per unit, not the ratio.
- C) Dividing sales revenue by variable costs gives the inverse of the contribution margin ratio.
Thus, the correct method for computing the contribution margin ratio is option D.