Define contribution margin, contribution margin per unit, and contribution margin percentage?
The correct answer and explanation is:
Contribution Margin is the amount remaining from sales revenue after subtracting variable costs that go into producing a product or service. It represents the money available to cover fixed costs and then contribute to profits. The formula to calculate the contribution margin is:
$$
\text{Contribution Margin} = \text{Sales Revenue} – \text{Variable Costs}
$$
Contribution Margin Per Unit is the contribution margin calculated for each individual unit sold. This figure helps to understand how much profit each unit contributes after covering variable costs. The formula is:
$$
\text{Contribution Margin Per Unit} = \text{Selling Price per Unit} – \text{Variable Cost per Unit}
$$
Contribution Margin Percentage expresses the contribution margin as a percentage of total sales. It shows what portion of each sales dollar is available to cover fixed costs and generate profit. The formula for contribution margin percentage is:
$$
\text{Contribution Margin Percentage} = \left( \frac{\text{Contribution Margin}}{\text{Sales Revenue}} \right) \times 100
$$
Explanation
The contribution margin is a key metric in business as it highlights the financial contribution each sale makes to cover fixed costs and generate profit. It is used to assess the profitability of individual products or services. Understanding this metric helps businesses determine how much each unit sold will contribute toward covering fixed costs and how quickly a company can break even.
The contribution margin per unit is important because it allows businesses to analyze the profitability of individual products, helping managers decide which products to prioritize. A higher contribution margin per unit indicates that a product is more profitable after accounting for its variable costs.
The contribution margin percentage provides insight into how effectively a company can convert sales into profits. A higher contribution margin percentage means that a larger portion of sales is available to cover fixed costs, which is beneficial in terms of reaching profitability sooner. This metric is particularly useful for making pricing decisions and evaluating the efficiency of cost management strategies.