5 Chapter 5- The Contribution Margin / Gross Profit-

Contribution Margin

The contribution margin (CM) is a financial metric that tells you how much money a company earns after covering its variable costs for producing a good or service. The leftover revenue contributes to paying for the company’s fixed costs and generating a profit.

Here is a breakdown:

• Variable costs: These are expenses that change with business volume (e.g., food cost, beverage cost, labor cost).
• Fixed costs: These are expenses that stay the same regardless of production volume, like rent, salaries for administrative staff, and utilities.

The contribution margin shows how much each sales dollar can pay for fixed costs and contribute to the bottom line (profit). Companies use contribution margins to understand pricing strategies, cost structures, and profitability.

See the contribution margin example below.  

Gross Profit

Gross profit, sometimes called sales profit or gross income, is a financial metric that shows a company’s profit after deducting the costs associated with producing and selling its products or services. In other words, it reflects a business’s initial profit before accounting for other operating expenses or taxes.

Here is a breakdown of how gross profit is calculated:

• Revenue: Total sales before any deductions.
• Cost of Goods Sold (COGS): These are the direct costs associated with producing menu items and providing service staff. They include the goods (food and beverage cost) and services (labor cost).

Formula: Gross Profit = Revenue – Cost of Goods Sold (COGS)

 Key points about gross profit:

• Gross profit looks at variable costs, not fixed costs like rent or salaries for administrative staff.

• It is an essential metric for understanding a company’s pricing strategy and ability to generate profit from its core business activities.

Gross profit is a stepping stone to Net Profit, which considers all the company’s expenses, including operating expenses, interest, and taxes. See the gross profit example below.

We will compare the food cost and the contribution margin of two menu items: a chicken dish and a shrimp dish.

Suppose we could design a menu to lead the customer to buy the items that we make the most profit on. We could engineer a menu to do this in the next chapter; that is what we will do with menu engineering.