When determining the value of the equity in a business, what is a good contribution margin for a company can mean different things to different people. Some people may view it as an accurate barometer of the health of the business. Others may see it as nothing more than a meaningless number.
The higher the contribution margin, the more cash is available to pay for the fixed expenses, or overhead costs, of the business. But it is also more likely that the contribution ratio is well above 100% and most likely below 50%. Therefore, the contribution margin also can be used as an accurate measure of the profitability of a specific product line, and/or a measure of the profitability of a particular company. But, as any stock trader will tell you, this is not the end of the matter.
There are two other concerns involved with what is a good contribution margin for a business. One concern pertains to the time-frame that relates to the performance of the business. The longer it takes for a company to generate profits, the lower the contributions may be. The second concern pertains to the fixed expenses that a business incurs. In essence, if the company does not incur any fixed expenses, then the contributors to the business will experience some “bonus” payments as they would if there were no contributions.
Now that we have the two concerns in hand, what is a good contribution margin for a business? If a company has adequate cash flow and is not experiencing any major or minor fixed expenses, then the contributions will not be too significant. In essence, there is not much wiggle room. It is very difficult to understimate the importance of the contribution margins in today’s economy. A company simply cannot afford to lose too much money when it comes to contributions to the business because of the high fixed costs associated with maintaining a certain level of productivity.
What is a good contribution margin for a business? Ideally, a company should have a positive net profit margin. This means that after taking into account the fixed expenses and variable costs, there should be some left over for its revenue stream. This is the “free market” rule of thumb. It is what will ensure the long term viability of the company. If there is not enough money generated from the sale of products, service, and/or the provision of labor and facilities, then there is no money coming in to support these operations and the operations stop running.
Ideally, a company should have a positive net profit margin but this does not mean that all profits are created equal. There are certainly some very good companies that are profitable, but there are also some extremely bad companies. A business’ profitability is usually determined by its sales mix: if there is too much profit from the sale of products and services but too little from the provision of fixed costs and labor, then you may be headed for bankruptcy. However, there are also some exceptionally good companies where the fixed costs are relatively low but the profit is very high.
Today’s business environment is very complex. You need to know the cost of doing business and how that is impacted by variables such as competition, customer service, pricing, and the contribution margins of the different operations. A good contribution margin ratio usually indicates that the profit margin is high and the price per unit is low. On the other hand, a low contribution margin percentage indicates that profits are low but the price per unit is high.
In addition, you should also know the performance of the market as long as it is not changing significantly. You need to keep in mind that a good contribution margin will not necessarily mean that your business is making a profit because some business can survive even with low or mediocre profits. Usually the best way to find out whether a business is profiting or not is to look at its operating and maintenance costs. These can also be affected by the level of competition. If you make a comparison of the cost of doing business and the performance of the market, you will be able to tell if a business is profiting or not.