What is Contribution?
Contribution is the amount of earnings remaining after all direct costs have been subtracted from revenue. This remainder is the amount available to pay for any fixed costs that a business incurs during a reporting period. Any excess of contribution over fixed costs equals the profit earned.
Direct costs are any costs that vary directly with revenues, such as the cost of materials and commissions. For example, if a business has revenues of $1,000 and direct costs of $800, then it has a residual amount of $200 that can be contributed to the payment of fixed costs. This $200 amount is the contribution arising from operations.
The contribution concept is usually referred to as contribution margin, which is the residual amount divided by revenues. It is easier to evaluate contribution on a percentage basis, to see if there are changes in the proportion of contribution to revenues over time.
Contribution should be calculated using the accrual basis of accounting, so that all costs related to revenues are recognized in the same period as the revenues. Otherwise, the amount of expense recognized may incorrectly include costs not related to revenues, or not include costs that should be related to revenues.
