Accounting profit is the net income companies receive after deducting expenses from revenues. It provides a base to measure financial performance during a financial period. However, companies may also use other metrics internally to gauge it. One includes contribution margin, which companies can translate into contribution per unit.
The base for contribution per unit comes from the underlying contribution margin concept. Therefore, it is crucial to discuss it first.
What is Contribution Margin?
Contribution margin is metric companies use to gauge profits. However, it does not use the same concept for measuring income. Contribution margin only considers variable expenses when calculating returns for products. Furthermore, it seeks profits for each product and unit instead of focusing on the financial performance as a whole.
The contribution margin is the difference between total sale revenues and variable costs. It also represents the return available to cover fixed costs. Subsequently, the residual amount contributes to the net profits for the period. These profits are the same as net income calculated in the income statement. However, the contribution margin method takes a different approach to it.
What is Contribution Per Unit?
The contribution margin allows companies to understand the returns for each product individually. On top of that, it also allows companies to consider each product unit. Contribution per unit refers to the contribution margin for a single item manufactured or purchased. Companies can use this information for various decisions made during the production process.
Contribution per unit refers to the difference between the sale price of a product and all the variable costs incurred for it. Since fixed costs do not contribute to the cost of a product, this information is crucial in several areas. One of these includes deciding the price of a single product. Companies can calculate the contribution per unit for every product manufactured or purchased.
How to calculate Contribution Per Unit?
Companies can calculate contributions per unit in different ways. The first method involves measuring the contribution margin for a product and dividing it by the total product units manufactured. In this case, the contribution per unit formula will be as follows.
Contribution per unit = Contribution margin / Total units
The above formula for contribution per unit assumes companies have already calculated the contribution margin. However, companies can expand this formula to achieve the same result. The adjusted formula is as below.
Contribution per unit = (Total revenues – Total variable costs) / Total units
Another contribution per unit formula involves calculating the per unit contribution margin. It is as below.
Contribution per unit = Sale price per unit – Variable costs per unit
Regardless of the formula used, the contribution per unit will be the same.
Example
A company, Green Co., sells different products. For one of its products, the company made total sale proceeds of $100,000. On the other hand, the variable costs for that product were $80,000. This data relates to 1,000 units manufactured during the period. With the above information, Green Co. calculates the contribution per unit as follows.
Contribution per unit = (Total revenues – Total variable costs) / Total units
Contribution per unit = ($100,000 – $80,000) / 1000 units
Contribution per unit = $20,000 / 1000 units
Contribution per unit = $20 per unit
Conclusion
The contribution margin is the difference between total sales and variable costs. Contribution per unit calculates the amount for each product manufactured or sold. Usually, companies use this information for pricing and other similar decisions. Companies can calculate contribution per unit using various formulas, as listed above.
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