Lessons · Accounting · contribution margin per unit
Contribution margin: what each sale leaves behind
Selling price minus variable cost per unit. It is what one more sale contributes towards the fixed costs, and once those are covered, towards profit.
Hone is a place to practise a career, one idea a day. This is one of its lessons, written out in full and free to read without an account.
In beta. This lesson was written for Hone and has not yet been checked by a qualified accountant. Practice material, not professional advice. What that means.
What it is for
It is the single most useful number in management accounting, and it is not gross profit. Gross profit takes out cost of goods sold, which usually contains fixed production cost. Contribution takes out only what actually changes when you sell one more, which is why it is the number every decision on this road is made from.
How to think about it
Take the price. Subtract everything that would not have been spent if that unit had not been made and sold: materials, piece-rate labour, sales commission, delivery. What remains is contribution per unit.
Worked example
Price 25.00, materials 9.00, piece-rate labour 4.00, commission 2.00Everything listed is avoidable if the unit is not sold.
Variable cost = 9.00 + 4.00 + 2.00 = 15.00Total of the avoidable per-unit costs.
Contribution = 25.00 − 15.00 = 10.00 a unitWhat each sale leaves towards fixed costs and profit.
At 3,000 units: total contribution = 30,000Contribution scales with volume. Fixed costs do not.
Your turn
Price 25.00 and variable cost 15.00. Write the line that gives contribution per unit.
Contribution = 25.00 − = 10.00
Solve one, graded on the server
The trap
Using gross profit where contribution is wanted. Gross profit has fixed production cost buried in it, so it moves when volume moves even if nothing else changed, and a decision made from it can be exactly backwards.