How to calculate contribution per unit
/What is Contribution per Unit?
Contribution per unit is the residual profit left on the sale of one unit, after all variable expenses have been subtracted from the related revenue. This information is useful for determining the minimum possible price at which to sell a product. In essence, never go below a contribution per unit of zero; you would otherwise lose money with every sale. The only conceivable reason for selling at a price that generates a negative contribution margin is to deny a sale to a competitor.
How to Calculate Contribution per Unit
To calculate the contribution per unit, summarize all revenue for the product in question and subtract all variable expenses from these revenues to arrive at the total contribution margin, and then divide by the number of units produced or sold to arrive at the contribution per unit. Thus, the calculation of contribution per unit is:
(Total revenues - Total variable costs) ÷ Total units = Contribution per unit
When only one product is being sold, the concept can also be used to estimate the number of units that must be sold so that a business as a whole can break even. For example, if a business has $10,000 of fixed costs and each unit sold generates a contribution margin of $5, the company must sell 2,000 units in order to break even. However, if there are many products with a variety of different contribution margins, this analysis can be quite difficult to perform.
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Costs to Include in Contribution Per Unit
The key component of the contribution per unit calculation that can cause difficulty is the variable cost. This should only include those costs that vary directly with revenues. Thus, it should not include any overhead cost, and should rarely include direct labor costs. Direct labor costs are actually a fixed cost when a production line is used, since it requires a certain fixed amount of staffing to operate the line, irrespective of the number of units produced.
Typically, variable costs are only comprised of direct materials, any supplies that would not be consumed if the products were not manufactured, commissions, and piece rate wages. Piece rate wages are paid based on the number of units produced; for example, if the piece rate wage is $4 per unit and a worker produces 10 units, then the total piece rate wage is $40.
Example of Contribution per Unit
To illustrate the concept of contribution per unit, ABC International has generated $20,000 of revenues in the most recent reporting period from sales of its purple widget. There are $14,000 of variable costs associated with these revenues, which means that the overall contribution margin for the purple widget was $6,000. Since ABC sold 500 purple widgets, the contribution per unit was $12 (calculated as $6,000 contribution margin ÷ 500 units sold).