What is the Unit Contribution Margin?
Unit contribution margin is the amount of the product selling price over and above the variable cost per unit; to put in simple words, it is the selling price of the product minus the variable cost that was incurred to produce the product.
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How to Calculate Unit Contribution Margin?
The formula is as follows:
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For eg:
Source: Unit Contribution Margin (wallstreetmojo.com)
Here, the variable costs per unit refer to all those costs incurred by the company while producing the product. These include variable manufacturing, selling, and general and administrative costs as well—for example, raw materials, labor & electricity bills. Variable costs are those costs that change as and when there is a change in the sale. An increase of 10 % in sales results in an increase of 10% in variable costs.
Explanation of Contribution Margin in Video
Unit Contribution Margin Examples
Example #1
Let us start by taking an example from the introduction. Also, let us assume that the selling price of a single cupcake is $20. The variable cost part of making a single cupcake is $10. Hence, the contribution margin per additional unit of the cupcake will be:
$20 – $10 = $10
It simply means that by selling this cupcake, the net income or profit increases by $10.
An important point to be noted here is that fixed costs are not considered while evaluating the contribution margin per unit. As a result, there will be a negative contribution to the contribution margin per unit from the fixed costs component.
Example #2
Let’s look at another example where a company manufactures furniture sets. The required data is as follows:
- The selling price of the furniture set = is $ 150
- Variable manufacturing cost = $ 80
- Variable labor cost = $ 30
- Variable selling and administrative cost = $ 10
- Number of units sold during the accounting periodAccounting PeriodAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company's overall performance.read more = 2500
As unit contribution margin formula = Sales per unit – Total Variable costs per unit
= $ [150 – (80+30+10)]
= $ [150-120] = $30
In the above example, the Total Contribution Margin would be calculated as follows:
- Total contribution margin = Sales Revenue – Total Variable Expenses
- Sales revenue = (Selling price)*(No. of units sold) = 150*2500
Sales Revenue will be:
- Total Variable expense = (Total variable costs per unit)*(no. of units sold)
- = (80+30+10)*(2500)
So, the Total Variable expense will be:
So, Total Contribution Margin = 375000-30000 = $ 75000
Total Contribution Margin will be:
Example #3
In this example, we’ll consider a case where a corporation is into multiple product manufacturing. Consider the below table for the required business data:
| (S) | Product A | Product B | Product C |
|---|---|---|---|
| Sales Revenue | 100000 | 185000 | 75000 |
| Cost of Goods Sold | 75000 | 150000 | 8000 |
| Admin Costs & Misc. | 1150 | 2500 | 250 |
| No. of Units Sold | 300 | 250 | 250 |
Total Variable cost for A = 75000+1150
Total Variable costTotal Variable CostTotal variable cost is the total of all variable costs that would change in proportion to the output or the production of units and helps analyze the company's overall costing and profitability. Total variable cost formula = number of units produced x variable cost per unit.read more for B = 150000+2500
Total Variable cost for C = 8000+250
And,
Total Contribution margin for A = $(100000-76150) = $ 23850
Total Contribution margin for B = $(185000-152500) = $ 32500
Total Contribution marginContribution MarginThe contribution margin is a metric that shows how much a company's net sales contribute to fixed expenses and net profit after covering the variable expenses. As a result, we deduct the total variable expenses from the net sales when computing the contribution.read more for C = $(75000-8250)= $ 66750
So,
Contribution Margin of A = $ (23850)/ (no. of units of A sold) = $ 23850/300 = $ 79.5
Contribution Margin of B = $ (23850)/ (no. of units of B sold) = $ 32500/250 = $ 130
Contribution Margin of C = $ (23850)/ (no. of units of C sold) = $ 66750/250 = $ 267
Note: As we can see here, while the revenue share is largest for Product B, Product C has the highest Unit Contribution margin. So in effect, it is product C that has the most profitability.
How is the Unit Contribution Margin Helpful to a Business?
- It helps us determine how an additional unit of a product affects the company’s profit. It is obtained by subtracting variable costs incurred while producing that additional product unit from its sale.
- It helps a business understand how profitable it is at the product level. It gives managers an essential insight into various aspects of the business and helps them make better-informed decisions. Again, referring to our earlier example, knowing the unit contribution margin of each of the products sold at the bakery will help the manager make several decisions.
- These decisions could range from deciding which product to continue or discontinue producing and selling, how many additional units of a product to be produced, how to set the product’s price, or how to determine the commissions on salesCommissions On SalesSales commission is a monetary reward awarded by companies to the sales reps who have managed to achieve their sales target. It is an incentive geared towards producing more sales and rewarding the performers while simultaneously recognizing their efforts. A sales commission agreement is signed to agree on the terms and conditions set for eligibility to earn a commission.read more.
Conclusion
While the contribution margin per unit formula is beneficial for managers to consider while maximizing their profits, making decisions solely based on it or even cutting out on products with the lowest margin might not always be right. Managers should also consider the fixed costThe Fixed CostFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.read more associated with the production alongside.
Overall, it provides valuable information when used with other parameters in making major business decisions.
Recommended Articles
This article has been a guide to Unit Contribution Margin and its meaning. Here we discuss the formula to calculate Contribution Margin per unit and how it is helpful to a business. You may learn more about financial analysis from the following articles –
