Definition: Contribution margin per unit is the dollar amount of a product’s selling price exceeds its variable costs. In other words, it’s the amount of revenues from the sale of one unit that is left over after the variable costs for that unit have been paid. You can think it as the amount of money that each unit brings in to pay for fixed costs.
What Does Contribution Margin Per Unit Mean?
The contribution margin per unit formula is calculated by subtracting the variable costs per unit from the selling price per unit.
Let’s look at an example.
A manufacturer produces 1,000 units and incurs variable costs of $5,000. It plans to sell its products for $10 each. The contribution margin per unit is $5 ($10 – ($5,000/1,000)). This means that after the variable costs are paid $5 is left over to pay the fixed costs associated with producing this product.
Management uses this formula to make production decisions and calculate selling prices in the future. For example, management might determine that its variable costs at 10,000 units are $5 a unit and fixed costs of $100,000. Dividing the fixed costs by 10,000 units, we get fixed costs of $10 a unit. At a selling price of $10 per unit, the contribution margin per unit would only be $5 and thus would not cover the fixed costs associated with manufacturing the product. The selling price would have to be raised to $15 to cover both variable and fixed costs.
This scenario can also change with increased production. Variable costs per unit tend to decrease as production levels rise. Fixed costs typically stay the same at all levels of production.
Let’s go back to our example. If this business increased production to 20,000 units, the variable costs per unit might decrease to $3 per unit. If the fixed costs remained constant, the selling price could be reduced to $8 and still cover the variable and fixed costs.