Definition: A unit contribution margin is the dollar amount that a product’s selling price exceeds its total variable cost. In other words, the unit contribution margin is the selling price of a product minus the variable costs incurred to produce that product.
What Does Unit Contribution Margin Mean?
Unit contribution margin measures the amount of the selling price of a unit that is used to cover fixed costs for that unit. Since companies’ cost structures are important for production and planning purposes, managers want to know how much fixed costs are distributed to each unit produced.
This is where the unit contribution margin calculation comes in. Unit contribution margin is important for managers to understand because it is used in order to calculate contribution margin ratio of products as well as break-even point analyzes.
Most manufacturers’ management divides costs into fixed and variable costs. Since variable costs are usually easy to track back to units being produced, variable costs can be estimated for each product produced. For instance, an auto manufacturer can could the labor hours and materials used to produce a fender on a car.
Often times, fixed costs aren’t easily traced back to individual products in the production line. The same auto manufacturer might not be able to trace utilities and insurance back to a specific product being produced. Some times fixed costs can only be estimated on a unit level.
That is why the unit contribution margin is important. Management can see how much income will be contributed to covering fixed costs. That way they can make sure the fixed costs are properly covered.
If a manufacturer produced products that sold for $50 a piece and required $30 of variable costs to build, the unit contribution margin would be $20.