Contribution Margin Ratio: What Is It & How to Improve It
byRunning a small business isn’t easy. You might have great sales, but certain factors can make it tough to stay profitable. Things like rising labor costs and unexpected expenses are especially challenging these days.
Despite these hurdles, the good news is that you can give yourself some extra breathing room. The solution lies in considering your contribution margin ratio (CMR). It’s a simple metric that shows how much of your sales revenue is available to cover fixed costs and drive profits.
Familiarizing yourself with your CMR can be the first step toward better profitability. And tools like When I Work can help you optimize your ratios by managing labor costs. On that note, let’s dive into what you need to know to calculate and improve your CMR.
Key takeaways:
Here are the main points you need to know about the functions of the CMR:
- It measures the percentage of sales revenue available after covering variable costs
- It helps businesses identify high-cost problem areas
- It enables better expense control
- CMR software solutions can help improve profitability
- A tool like When I Work can simplify labor management to optimize your CMR
Table of contents:
- What is the contribution margin ratio? Definition and formula
- Why the contribution margin ratio matters
- Signs your ratio may need improvement
- How software solutions can help you optimize your contribution margin ratio
- How When I Work supports your ratios
What is the contribution margin ratio? Definition and formula
A contribution margin ratio is a benchmark that shows the percentage of your company’s revenue that’s left after subtracting your variable costs. To determine your contribution margin ratio, you must first understand your contribution margin. It is the incremental cash you generate for each product you sell minus the variable part of your costs. In simpler terms, it shows how each product contributes to your general profitability.
Your CMR is a percentage. It shows what remains of each sales dollar after covering those variable costs. The amount helps manage fixed costs and is what becomes your profit.
Contribution margin ratio formula
The formula for determining your CMR is as follows:
Contribution Margin Ratio = (Sales Revenue – Variable Costs) / Sales Revenue
Say you own a coffee shop that sells $10,000 worth of coffee in a month. Your variable costs (coffee beans, cups, and labor) come out to $4,000. Plugging these numbers into the formula yields the following result:
CMR = ($10,000 – $4,000) / $10,000 = 0.6
As such, 60% of your revenue goes toward covering fixed costs (like rent and insurance) and profit.
When is the ratio used? By whom?
Most businesses can and should use the CMR formula. But in industries such as food service, retail, and hospitality, it is crucial. It not only provides a metric that helps account for variable costs like inventory and labor. It ensures enough money remains to cover fixed costs and provide a healthy profit margin.
Why the contribution margin ratio matters
Your CMR is so important because it does the following for your business:
Pinpoints high-cost problem areas in your business
Your CMR highlights where your money is going. And a low ratio often signals high variable costs. For example, suppose that you run a bakery with a low CMR. You might discover you’re spending too much on overtime.
You’ll need to unpack your variable costs further to get to the bottom of CMR issues. In the same example, you’d need to figure out why you are paying so much in overtime. You may be shorthanded. And that could mean you may need to rethink your scheduling issues.
Once you figure out the “why,” you can determine the “how” and then fix the issue to make your business more profitable.
Improves your labor budgeting
Labor is often one of the highest costs in a business. In fact, it is likely your single largest expense. If you know your CMR, you can explore more efficient ways to divide labor. It may mean reducing staff during slow periods. On the flip side, it could mean hiring more people to decrease overtime spending.
Helps you control rising expenses
A strong CMR gives you a sort of safety net amid rising variable expenses. If you see your ratio shrinking, you may need to adjust prices or cut unnecessary expenses. For example, if your CMR drops due to higher inventory costs, you might want to switch suppliers.
Addresses inefficiencies in profitability
Even businesses with strong sales can struggle if their CMRs are too low. Improving yours will help solve issues like excessive overtime or poor product performance. You want to ensure every dollar contributes to profitability. And managing your CMR will help you do it.
Signs your ratio may need improvement
Here are some warning signs that your CMR could be holding your business back:
Overstaffing leading to wasted labor costs
Too many employees on the clock during slow periods means wasted money. Overstaffing is a common issue for businesses without clear scheduling tools. The result is greater labor costs and a lower CMR.
High overtime expenses that drain your profits
Overtime can eat into your profits in no time. Say that your employees tend to work longer shifts due to poor scheduling or unexpected call-outs. Many times, you can fix these issues by rethinking how you approach scheduling.
Low profitability despite high sales
If you’re moving a lot of goods but still struggling to see a profit, your CMR might be too low. High variable costs like expensive inventory could be eating into your revenue. Still, don’t feel as though you need to scrap your product lineup completely. Sometimes, removing or changing some lackluster items can get your CMR back on track.
Struggling to cover fixed costs
Suppose that your business is always struggling to cover its fixed expenses. That’s a sign that its CMR likely isn’t high enough to support operations. Explore your variable costs and identify areas where you may be able to save money. You may need to adjust both your labor and product strategies to make up the difference.
How software solutions can help you optimize your contribution margin ratio
Employee scheduling software, such as When I Work, can help you improve your CMR with tools such as:
Automated scheduling with labor forecasting
Automated scheduling tools optimize staff allocation. They help forecast labor needs so you can ensure shifts are neither over- or understaffed. Labor forecasting itself also helps predict busy and slow periods. With that knowledge, you can staff your business as needed.
Let’s say your business operates 60 hours per week. And you overstaff your shifts by one person on average. That mistake translates to 60 hours of unnecessary labor expenses. By eliminating that wasteful spending, you can improve CMR by a great amount.
Overtime management and alerts
When I Work tracks employee hours and can alert you when someone is approaching overtime. All overtime isn’t bad, but you want to avoid excessive overtime spending. That’s a key way to keep your labor expenses in check. If you realize someone will pass the overtime threshold, you could flex them off or send them home early.
Real-time shift tracking and timesheets
Time theft can wreck your budget. Tracking when employees clock in and out will help you avoid paying for hours that they did not actually work. If people arrive late or leave early, you can adjust your timesheets as needed.
Employee availability management
When I Work makes it easy to visually track employee availability. The feature ensures that employees are scheduled based on when they can actually work. It will prevent higher-paid employees from being brought in when more cost-effective staff members are available. For example, you wouldn’t want to book a manager to cover a line-level position.
Integration with payroll systems
The best employee scheduling solutions work with popular payroll systems. In turn, they’ll save you time and promote expense visibility. Once merged, the employee scheduling tool will automatically sync worked hours with your payroll system. That guarantees the right pay for each of your team members.
Integration with payroll systems also reduces your administrative costs. By cutting back on your admin expenses, you can further improve your CMR.
How When I Work supports your ratios
When I Work features a wealth of tools designed to simplify workforce management. Its team communication app keeps everyone on the same page about when they work. A built-in time clock ensures you know how many hours each person is logging, so you can cut back on labor costs. You can even customize an automatic scheduling feature for almost any shift format, including rotating shifts.
When I Work helps you get to the bottom of labor-related CMR challenges. With our software, you can pinpoint overtime overages and avoid scheduling conflicts. Altogether, When I Work helps you better manage and reduce your labor costs. And that means it will help boost your CMR and profitability as a whole.
Explore When I Work to improve employee management and cut labor costs
The contribution margin ratio of any business is an integral metric that helps identify labor-related overspending. The question is, how can you fix your labor issues once you find them? With tools like When I Work, managing labor costs becomes simple and effective. Try When I Work for free today and see the difference for yourself.
