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.
How to Calculate Unit Contribution Margin?
The formula is as follows:
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.
Unit Contribution Margin Examples
Let us start by taking an example from the introduction. Also, let us make the assumption 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
This 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. In reality, there will be a negative contribution to the contribution margin per unit from the fixed costs component.
Let’s look at another example where a company manufactures furniture set. The required data is as follows:
- The selling price of furniture set = $ 150
- Variable manufacturing cost = $ 80
- Variable labour cost = $ 30
- Variable selling and administrative cost = $ 10
- Number of units sold during the accounting period = 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, Total C0ntribution 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:
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:
Total Variable cost for A = 75000+1150
Total Variable cost for B = 150000+2500
Total Variable cost for C = 8000+250
Total Contribution margin for A = $(100000-76150) = $ 23850
Total Contribution margin for B = $(185000-152500) = $ 32500
Total Contribution margin for C = $(75000-8250)= $ 66750
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 that while the revenue share is largest for Product B, it is Product C which has highest Unit Contribution margin. In effect, it is product C which has the most profitability.
How Unit Contribution Margin is Helpful to a Business?
- It helps us determine how an additional unit of a product affects the profit of the company. This is obtained by subtracting variable costs incurred while producing that additional unit of product from the sale of the product itself.
- It helps a business understand how profitable it is at the product level. This gives managers an important 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 price of the product or how to determine the commissions on sales.
While the contribution margin per unit formula is a very helpful matrix for managers to consider while maximizing their profits. Making decisions solely on the basis of it, or even cutting out on products that have the lowest contribution margin might not always be the right thing to do. Managers should also consider the fixed cost associated with the production alongside.
Overall, it provides valuable information when used with other parameters in making major business decisions.
This 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 –