If you are responsible for a business, you’ll want to know the contribution margin of each product your company sells, because it will reveal how much revenue you can expect to make every time your business sells one unit of a given type of product. You can calculate an item’s contribution margin by simply subtracting the variable expenses your business incurs to produce one unit of that particular product from the item’s selling price.
Variable, Fixed and Mixed Expenses
Variable expenses fluctuate depending on the number of products your business produces. In general, variable expenses such as labor will increase in correlation with an increase in production and decrease when your business produces fewer pieces of merchandise.
Fixed expenses differ from variable costs, because they remain static regardless of the number of products your business produces. Examples of fixed expenses include the costs your company pays to rent offices and equipment.
Mixed expenses are costs that have variable and fixed components. An example of a mixed expense would be money paid to an employee that consists of both a portion of the person’s annual salary and a commission earned for a sale the employee made.
Calculating Contribution Margin
To calculate a certain product’s contribution margin, subtract the sum of the item’s variable expenses plus the variable portions of its mixed expenses from the piece’s sales price. The sum of the costs included in this equation will be the same when additional units of the same product are produced.
If your business sells cashmere blankets for $200 apiece, and your company incurs a total of $35 in variable expenses and a variable portion of mixed expenses of $5 per blanket, the contribution margin of each blanket would equal $160, or $200 - ($35 + $5). This means that every time your company sells a cashmere blanket, your business will collect $160 in revenue that can be used to pay its fixed expenses and accumulate profits.
Using Contribution Margin
In addition to revealing how much revenue your business makes when it sells a certain product, an item’s contribution margin can be useful when you consider making changes to a product’s price, because you’ll be able to immediately calculate how a price change will impact your company’s gross revenues. You can also use an item’s contribution margin to determine your company’s break-even point, meaning you can calculate the number of units of a particular product your business will have to sell in order to cover the fixed expenses it incurs in a given period of time.
For instance, if your business pays $3,000 in fixed expenses every week and the one product it sells has a contribution margin of $60, your company’s break-even point will equal $3,000 divided by $60, or 50 units. In other words, if your business sells 50 product units, it will break even and record neither a loss nor profit for the time period. If your company sells 51 or more products, it will record a net profit.
Deborah Barlowe began writing professionally in 2010. With experience in earning securities and insurance licenses and having owned a successful business, her articles have focused predominantly on finance and entrepreneurship. Barlowe holds a bachelor’s degree in hotel administration from Cornell University.
Hemera Technologies/Photos.com/Getty Images