What is the difference between gross margin and contribution margin, and which is more relevant for budgeting profitability?

• A. Gross margin is revenue minus COGS; contribution margin is revenue minus variable costs
• B. Gross margin equals net income; contribution margin equals gross margin minus taxes
• C. Gross margin is revenue minus fixed costs; contribution margin is revenue minus total costs
• D. Gross margin equals revenue minus variable costs; contribution margin equals revenue minus COGS

Answer: (A)

The big difference lies in which costs are subtracted from revenue. Gross margin subtracts the cost of goods sold, giving you profit after production costs. Contribution margin subtracts all variable costs, so you’re left with the amount available to cover fixed costs and to contribute to overall profit. For budgeting profitability, the contribution margin is more relevant because it shows how changes in volume and variable costs affect the funds available to cover fixed costs and generate profit. That helps with pricing, production levels, and product mix decisions. The other descriptions don’t match how these margins are defined: gross margin isn’t net income, taxes aren’t part of the margin, fixed costs aren’t subtracted to get gross margin, and contribution margin isn’t revenue minus COGS.