Contribution Format Income Statement: Definition and Example (2023)

As a business owner, you’ve likely prepared a traditional income statement, with the usual line items for revenue and expenses, with net income on the bottom line. 

This standard format can give you a great financial snapshot of how your business is doing. But if you’d like to dig deeper and shed light on how costs affect your profit, a contribution format income statement can help. 

Here’s what you need to know about contribution format income statements, how to structure them, and how they can benefit your business.

What is a contribution format income statement?

A contribution income statement is an income statement that separates the variable expenses and fixed costs of running a business. Variable expenses are subtracted from sales to calculate the contribution margin. Then, fixed expenses are deducted to show the final operating income. 

Variable expenses fluctuate based on the business’s usage or output, such as utility bills or raw materials. Fixed production costs, such as rent or salaries, remain constant, regardless of business activity or output.

Contribution margin income statements can help business managers control costs, set prices, and make decisions about business segments, such as expanding profitable product lines or discontinuing less profitable ones. These financial statements are primarily for internal use by managers. Traditional income statements are for regulators and investors because they meet generally accepted accounting principles (GAAP), a set of rules the US Securities and Exchange Commission (SEC) requires in the preparation of financial statements of publicly traded companies.

A contribution margin income statement reaches the same bottom-line result as a traditional income statement. While the contribution format sorts costs by whether they are variable or fixed, a traditional income statement separates costs by whether they are tied to production or not. These include the cost of goods sold (COGS) as well as selling, general, and administrative costs (SG&A). The two expense categories may contain both fixed and variable costs, which is why it can be useful to separate them using a contribution format statement.

The contribution format income statement is also known as a contribution margin income statement or a variable-cost income statement. 

Example of a contribution margin income statement

Using a hypothetical company, let’s look at how a contribution margin income statement compares to a traditional income statement.

ABC Cabinets Inc. makes bath and kitchen cabinet sets and sells fixtures such knobs, handles, and faucets. A contribution format income statement, might look like this (in US dollars):

Sales of cabinet sets	1,600,000
Sales of fixtures	900,000
Total revenue	2,500,000
Variable costs:
Materials, hourly labor	1,100,000
Storage, shipping, utilities	150,000
Total variable costs	1,250,000
Contribution margin (sales – variable costs)	1,250,000
Fixed costs:
Office rent	50,000
Salaries, utilities	150,000
Total fixed costs	200,000
Operating income (contribution margin – fixed costs)	1,050,000

  

By comparison, a basic traditional income statement might look like this:

Revenue	2,500,000
Cost of goods sold (COGS)	1,350,000
Gross profit (revenue – COGS)	1,150,000
Selling, general, administrative costs (SG&A)	100,000
Operating income (Gross profit – SG&A)	1,050,000

 

 Both methods lead to the same operating income, though they arrive via a different route.

Contribution margins also can be expressed as ratios. The formula is:

(Revenue – Variable Costs) / Revenue = Contribution Margin Ratio

From the statement above, we can see ABC’s contribution margin is 50%:

($2,500,000 – $1,250,000) / $2,500,000 = 0.5 or 50%

ABC Cabinets can use the contribution format for segment analysis, evaluating its two business segments and their relative contribution margins. Managers would have to determine the allocation of variable and fixed costs to each segment. Let’s say the allocations are as shown below.

Segments	Cabinets	Fixtures
Sales	1,600,000	900,000
Variable costs:
Materials, hourly labor	900,000	100,000
Storage, shipping, utilities, selling	100,000	150,000
Total variable costs	1,000,000	250,000
Contribution margin (sales – variable costs)	600,000	650,000
Contribution margin ratio	37.5% (600,000 / 1,600,000)	72.2% (650,000 / 900,000)
Fixed costs:
Office rent	25,000	25,000
Marketing, salaries, payroll/accounting	75,000	75,000
Total Fixed Costs	100,000	100,000
Operating income (contribution margin – fixed costs)	500,000	550,000

 

ABC Cabinets can also use contribution margin analysis to understand each product segment’s break-even point, or the point where it begins to make a profit. A break-even analysis can help a company determine how much in dollar sales it must generate to break even.

Determine the break-even point using the following formula.

Fixed Costs / Contribution Margin Ratio = Break-even Sales

For example, for the cabinets segment the break-even sales point would be:

100,000 / 37.5% or 0.375 = $266,667

For fixtures, the same formula produces the following result:

100,000 / 72.2% or 0.722 = $138,504

Managers at ABC Cabinets would conclude from segment analysis that the fixtures segment is more profitable because it has a higher contribution margin. Using the formulas above, they could also see that the cabinet segment needs to generate almost double the sales compared to the fixtures segment to reach the break-even point.

What’s the difference between a contribution format and a traditional income statement?

A contribution format statement differs from a traditional income statement in several ways:

Cost accounting

Contribution format statements separate expenses into fixed and variable costs. Traditional income statements separate costs by production (COGS) and administration (SG&A), each of which may be a mix of variable and fixed costs. Each method results in the same operating income.

Different margins

Traditional statements calculate gross profit margin, which is determined by subtracting the cost of goods sold (COGS) from revenue. Contribution format statements produce a contribution margin, which is the result of subtracting variable costs from revenue. Variable costs are less than COGS, which also may include fixed and variable costs, so a business’s contribution margin is usually higher than its gross margin.

General vs. specific

Traditional income statements are used to evaluate the overall profitability of a business. Contribution formats are more detailed, and are useful for evaluating business segments, such as subsidiaries or divisions, or individual product lines. They’re also useful for managers determining how sensitive variable costs are to a change in sales or production.

Internal vs. external use

Contribution format statements are for internal use by businesses. Traditional statements are required because they conform to GAAP accounting standards, and they are prepared for external audiences, including investors, lenders, and regulators.