Every business owner's goal is to have enough money to keep operations running. The unit contribution margin helps a company assess its cost landscape on the most basic level. This is to determine its chances of reaching target profits and, if so, how soon.
Moreover, it is a cost-effective method that influences managers' decisions to continue or stop a product line that is failing to meet expected results.
What is the unit contribution margin?
The unit contribution margin represents a product's selling price per unit minus associated variable costs per unit. It is a part of a company's cost-volume-profit analysis to determine its breakeven point or target profit margin at a given period.
Simply put, the unit contribution margin measures profitability at the product level. In a positive unit contribution margin or when the selling price is higher than the variable cost, each incremental unit produced and sold contributes to covering fixed costs and leads to higher profitability.
Conversely, a negative unit contribution margin indicates a loss at a micro level. Your business cannot continue running in a sound financial state if the cost of production outweighs the margin.
How to find the unit contribution margin?
Before proceeding with a detailed guide on finding unit contribution margin, the first step is to know your fixed and variable costs. You will use these often, particularly variable costs, to calculate unit contribution margin.
Variable costs - costs to produce a good affected by the number of units sold, such as:
- Raw material costs
- Factory labor (piece rate) costs
- Electricity costs
- Logistics, e.g., packaging and delivery costs
Fixed costs - costs to produce a good that remains fixed regardless of the number of units sold. Some textbook examples include:
- Rent or lease costs
- Insurance expenses
- Depreciation adjustments
Fixed costs and variable costs vary for every company as each has its unique business model, product line, operational structure, and production inputs.
What is the formula for unit contribution margin?
Unit contribution margin is one of the easiest formulas in accounting.
To get the contribution margin per unit, deduct the total variable cost per unit from the selling price per unit.
How to find the contribution margin per unit using sales revenue?
Alternatively, you can find the unit contribution margin using sales revenue as a starting point. Honestly, this data is very accessible, given that business owners like to keep a score of their sales.
To get the unit contribution margin using sales revenue, get the difference between total sales revenue and total variable costs and divide the result by the total number of units sold. Follow the formula below as a guide:
How is the unit contribution margin calculated?
Here are some examples to see how to calculate contribution margin.
Example 1. Using the formula: Selling price per unit – variable cost per unit = Unit contribution margin
Say you have a journal manufacturing company and the journal's selling price per unit is $20. The variable cost to make every unit is $12.
$20 revenue per unit – $12 variable cost = $8 unit contribution margin or 40% of your revenue per unit
Example 2. Using the formula: (Sales revenue – total variable costs) / number of units sold = Unit contribution margin
You made $1,000 in total sales revenue after selling 100 units of strawberry bonbons at a $10 selling price per unit. Your total variable cost for manufacturing, labor, and logistics is $400.
($1,000 sales revenue – $400 total variable costs) / 100 Units of Strawberry Bonbons Sold
$600 is your total contribution margin. Divide it by the total number of units sold to get the contribution margin per unit. In this case:
$600 Total Contribution Margin / 100 Units of Strawberry Bonbons Sold = $6 Unit Contribution Margin or 60% of your revenue per unit
Unit contribution margin to assess a product's profitability
Businesses need to know if a good can deliver its expected profitability target. Otherwise, it would be a waste of time and resources.
The unit contribution margin is a straightforward way to see the viability of a product. But, it also proves that products with the highest onset revenues are not always the most profitable. This example will show why.
Suppose you are doing a multi-product production for toy slimes and animal plushies.
Product A: Toy slimes
- Sales revenue - $20,000
- Variable costs - $16,000
- Total units sold - 200 units
($20,000 sales revenue - $16,000 total variable costs) / 200 total units sold = unit contribution margin
$4,000 is the difference between sales revenue and total variable costs / 200 total units sold = $20 unit contribution margin
Product B: Animal plushies
- Sales revenue - $6,000
- Variable costs - $2,000
- Total units sold - 50 units
($6,000 Sales Revenue - $2,000 Total Variable Cost) / 50 Total Units Sold = unit contribution margin
$4,000 is the difference between sales revenue and total variable cost / 50 Total Units Sold = $80 unit contribution margin
In this example, product A (toy slimes) has a higher sales revenue and volume of units sold but has a lower contribution margin. Whereas product B (animal plushies) has lower sales revenue and volume of units sold, it has a higher contribution margin.
The main difference is the variable cost ratio to sales. The toy slime has a higher input cost, lowering its contribution margin per unit. This example shows that products with higher sales revenue can give a false sense of profitability, and businesses should be careful of this trap. It's always a good idea to know your unit contribution margins if you have multiple products.
Low and high contribution margin per unit results
A low contribution margin per unit shows that a business makes a loss at a product level.
While products with a high contribution margin per unit are the gems of your business, in this case, the more units sold for a good with a high unit contribution margin, the easier it is to cover fixed costs.
But remember, some products will not reach profitability until reaching the ideal volume of units sold. If you find yourself in this situation, ask yourself if it is worth going the extra mile on input to reach desired results.
A unit contribution margin is a straightforward way to assess if your product can cover production expenses.
Deduct the variable expenses per unit from the selling price per unit to get the unit contribution margin. This is the easiest way to know if you have enough to cover fixed expenses.
Applying the opportunity cost principle, the unit contribution margin is a compass that helps business owners set their priorities straight by directing resources to profitable goods and cutting money-losing ventures early on.