The contribution margin represents a financial calculation that deals with a company’s ability to have enough revenue to cover the variable cost of a product.
Calculating Variable Costs
Some variable costs that go into a product include materials, labour, and utilities.
For example, you set the price of a product at $150. You pay $10 for the materials and $15 for the labour to manufacture each unit of this particular product. You also incur an additional $25 in variable costs to sell this product due to the fees you use for sales and the utilities needed to make the product in your facility. Your total variable costs come to $50.
Calculating the Contribution Margin
To calculate the contribution margin for this particular product, start with the price and then subtract the variable costs. The contribution margin for this product is $150 minus the $50 in variable costs for a total of $100. Use the contribution margin for all of your products to compare which products do well and which ones you may need to tweak.
The contribution margin lets you calculate how much each individual product contributes to the profit margin of your business. Use this information to distinguish your best-selling products from ones that don’t do very well. Analysing your contribution margins for product lines lets you adjust your sales price, plan for the future, and figure out how to price items throughout the year.