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TROYHENIKOFF
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Do You KNOW the Difference between Gross Profit and Contribution Margin?

November 21, 2019

Transcript

All right. Today we're going to talk about the difference between gross profit and contribution margin. Two terms that are very similar and people get confused all the time. I want to make sure you understand the differences so that you use them properly and you don't risk credibility in using them improperly in an investor meeting. So both of these concepts are related to how much money you bring in and what the cost of delivering that product or service is. But they're different. You see, gross profit is a different product or service.

profit is generally looking at the whole company how much revenue in total do you bring in in the

period what is the cost of goods sold for those products and services what is any direct packaging

shipping things directly associated with the servicing of those products that is your gross

profit that number or those dollars then go to paying for all the other things the company has

to do contribution margin on the other hand is about an individual product what is its revenue

its cost of goods sold packaging shipping etc and that's the contribution margin from that product

now those sound very similar the difference is the contribution margin is kind of an individual

photograph and gross profit is sort of a group photo but there is one subtle other difference

there are some costs that are difficult to allocate to an individual product but are

necessary for the company to run for shipping all of the products an example might be a warehouse

manager the cost of that warehouse manager will get baked into gross profit or subtracted from

the gross profit but it will not appear anywhere in the contribution margin because the warehouse

manager isn't necessary for any single product but it's necessary for operating the company as a whole

hopefully this clarifies the difference and you understand the difference now and we'll use the

terms properly between contribution margin the single photograph gross profit the group photo

and it'll make you more effective at running your business and hopefully make it an easier time

raising money

Do you know the difference between Gross Profit and Contribution Margin? These are two terms that are very similar and often confused. Getting it right can help you, especially when communicating with investors! Here is Troy’s simple explanation.

5 Comments

  • Troy Henikoff February 21, 2021
    @Matt, "Contribution Margin" is a very specific term that refers to the amount of money earned when selling a particular product or service. If I sell a widget for $10.00 and the cost of the Widget is $4.00, Packaging is $1.50 and Shipping is $2.00, my contribution margin is $10.00-$4.00-$1.50-$2.00 = $2.50. "Unit Economics" is usually referring to the entire life cycle of a customer – What did I spent in advertising/sales to get the customer and then how much profit do I make off the customer over the lifetime of the customer. So, Contribution Margin is an input into the larger Unit Economics. Hope that helps!
  • Matt Wolf February 21, 2021
    Hi Troy, thank you for this. Are contribution margin and unit economics synonymous?
  • Matthew Wolf February 22, 2021
    @Troy. It sure does, thank you!
  • Alex Harrison February 27, 2024
    For those “difficult to allocate costs,” which apply to many or all of a company’s products, do you attempt to average them into the expenses for each product that it applies to? If yes, do you allocate it relative to price, or simple unit count? Your videos are phenomenally helpful across the board. Thank you!!
    • Troy Henikoff February 28, 2024
      If I understand the question, it is where you have a variety of products and there are some costs that apply across them. A simple example is in an eCommerce business, you have a cost for each product, but how do you allocate labor, warehouse rent, heating, etc. This is where the difference between Contribution Margin (on each specific product, Sale Price – COGS) vs. Gross Profit where you look at the entire operation, take all the sales minus all the COGS and all the other direct costs (labor, warehouse rent, etc) comes in. It makes it so you do not need to allocate all those costs. I hope this makes sense!

Comments are closed. These were carried over from the original post.

Originally published on the MATH Venture Partners blog.