Final answer:
The contribution margin ratio indicates the percentage of each dollar of sales that contributes to covering fixed costs and generating net income. It's calculated by dividing the contribution margin by sales revenue. This metric is vital for businesses to gauge their profitability and how sales affect their net income.
Step-by-step explanation:
The contribution margin ratio is interpreted as the percent of each dollar of sales that is available to cover fixed costs and contribute to net income. To calculate it, you divide the contribution margin (sales revenue minus variable costs) by the sales revenue. This ratio is integral for businesses to understand how changes in sales levels affect their net income.
Accounting profit is a critical term related to the contribution margin, defined as total revenues minus explicit costs, including depreciation. Similarly, average profit, also called profit margin, is derived by dividing profit by the quantity of output produced. When understanding the various components of a firm's profitability, it's crucial to also consider average total cost and average variable cost.
For instance, if a company has a high contribution margin ratio, it signifies that it has lower variable costs relative to total sales, thus can generate more profit from each sale. However, one must also consider other factors affecting profitability, such as economies of scale and diseconomies of scale, as well as economic profit, which takes into account both explicit and implicit costs.