Understanding contributions margins

When selling products, it is very important to understand contribution margins (🇳🇴 dekningsbidrag), and the mechanisms around it, both to understand which sales price should be set on each product, and also to help understanding how much discounts you can offer on a specific product.

Example

In this example we follow a product all the way from being purchased to being sold, and where we will also look at how much discount you potentially can offer.

Note that when counting expenses, it is very important to understand the difference between CM1 (Contribution Margin 1) and CM2 (Contribution Margin 2): CM1 = The revenue minus direct costs, like the actual cost for purchasing the product. The CM1 also shows how much is left to cover CM2. CM2 = CM1, minus the additional expenses, like house rental for the store, salary to the employees, and more. In our examples we use CM1 unless specified otherwise.

Preparations

• You purchase the product ZEISSVICTORY for NOK 1.000 ex. VAT from your supplier Zeiss Watches. Your total expense is then NOK 1.000, and everything on top of that is your profit.

• You decide to sell the product for NOK 10.000 incl VAT to your customers.

• The product has a VAT of 25%.

Finding the contribution margin: (🇳🇴 dekningsbidrag 1 or DB1)

1. To find the contribution margin we first need to remove the VAT: Net Sales Price = (Sales Price (incl. VAT) / 1 + VAT rate) = NOK 10.000 / 1,25 = NOK 8.000

2. Next we need to get the contribution margin, which is basically your profit: Contribution Margin = Net Sales Price - Cost Price = NOK 8.000 - NOK 1.000 = NOK 7.000 This means that for each product sold, NOK 7.000 is available to both cover fixed costs and generate profit.

Flow Retail will show the contribution margin both in amount and also in percentage.

Finding how much discount you can offer

This of course heavily depends on various factors, like how efficiently the business is being run, etc., but lets try with a relatively general example:

Since the product costs NOK 1.000 ex. VAT, you will need to add the VAT to the price, as you have to pay the VAT. The break-even price is therefore NOK 1.000 + 25% = NOK 1.250.

This means you can sell the product for NOK 1.250 and basically earn nothing. Which is normally pointless, and so you would want to add a minimum contribution margin on top of this, for lets say NOK 2.000 (to cover fixed costs, etc.). This means the lowest price you can sell for is NOK 1.000 + NOK 2.000 = NOK 3.000, and with the added VAT on top of that you get NOK 3.000 + 1,25 (25%) = NOK 3.750.

So, to ensure a certain contribution margin, you should at maximum discount the product down from NOK 10.000 to NOK 3.750, which will cover internal costs (house rental, salary, Flow Retail license, etc.) for a total amount of NOK 2.000.

Where and how can I see this in Flow Retail?

1. Add one or more products to an order (to become a sale)

2. Press cmd+b / ctrl+b in Keyboard-mode, or tap and hold DG in Touch-mode

3. You can now see the contribution margin per product, both as an amount and also as a percentage

What is a good contribution margin?

Anywhere between 20-60% is normal, with most retailers clocking in between 30-50%.

A contribution margin of 40% means that practically 40% of the revenue will go into covering the fixed costs like house rental, salary, etc., and the remaining 60% will be for variable costs, which includes purchasing the product, shipping from your supplier, and so on - and also hopefully to generate some profit on top.

The higher the contribution margin percentage, the more is left for profit.