Sales Margin (Contribution Margin)

Definition

The term sales margin refers to an operating performance measure that allows analysts to understand the profitability of individual revenue-generating activities.  Sales margin helps the company's management team to understand the effectiveness of individual product lines.

Calculation

Sales Margin = (Gross Profit Margin - Sales Expense) / Gross Sales

Where:

  • Gross Profit Margin = Net Sales - Cost of Goods Sold + Sales Returns
  • Sales Expense:  includes costs associated with running the sales department, such as direct sales labor, sales travel expenses, customer service, warranty and field maintenance, promotions, advertising and shipping costs.

Explanation

Operating performance measures allow investor-analysts and company management to understand how well a company is performing with respect to sales, margins, and profits.  Also known as contribution margin, sales margin is oftentimes used to measure the profitability of an individual product line since sales and distribution costs can vary considerably across products.

Sales margin takes the company's net sales and subtracts out the cost of goods sold, thereby isolating a product's gross profit margin.  Any sales returns are added back to derive a net value.  From the gross profit margin the cost of sales is subtracted, providing the analyst with a clear view of a product's profits before administrative overheads are applied.  This value is then divided by gross sales to provide the product's sales margin or contribution margin.

As is the case with other sales ratios, the analyst must take into consideration seasonal effects.  For this reason, this metric is typically tracked, and reported, over relatively long timeframes.

Example

Company A not only sold appliances but also offered repair contracts on refrigerators and washing machines.  Company A's management team wanted to compare the profitability of each offering by examining each product's sales margin.  The information for these two products appears in the tables below.

Washing Machine Contracts Year 0 Year 1 Year 2 Year 3
Gross Sales $5,430,000 $5,674,000 $5,929,000 $6,196,000
Less:  Sales Allowances and Returns $380,000 $397,000 $415,000 $434,000
Net Sales $5,050,000 $5,277,000 $5,514,000 $5,762,000
Less:  Cost of Goods Sold $3,283,000 $3,430,000 $3,584,000 $3,745,000
Gross Profit Margin $1,767,000 $1,847,000 $1,930,000 $2,017,000
Less:  Sales Expense $977,400 $1,049,690 $1,126,510 $1,208,220
Sales Margin 14.5% 14.1% 13.6% 13.1%

 

Refrigerator Contracts Year 0 Year 1 Year 2 Year 3
Gross Sales $4,344,000 $4,539,000 $4,743,000 $4,956,000
Less:  Sales Allowances and Returns $248,000 $259,000 $270,000 $282,000
Net Sales $4,096,000 $4,280,000 $4,473,000 $4,674,000
Less:  Cost of Goods Sold $2,253,000 $2,354,000 $2,460,000 $2,571,000
Gross Profit Margin $1,843,000 $1,926,000 $2,013,000 $2,103,000
Less:  Sales Expense $673,320 $726,240 $782,595 $743,400
Sales Margin 26.9% 26.4% 25.9% 27.4%

Company A's management team was surprised to learn that even though the gross sales on refrigerator contracts were 20% lower than washing machines, the sales margin value was over 10% higher.

Related Terms

goodwill to assets ratio, overhead to cost of sales, revenue margin of safety, revenue break-even point, gross profit index, operating income to sales, investment income performance, operating profit margin