Contribution margin is revenues minus all variable costs, which yields the amount of contribution margin available to pay for fixed costs. To calculate the contribution per unit, summarize all revenue for the product in question and subtract all variable costs from these revenues to arrive at the total contribution margin, and then divide by the number of units produced or sold to arrive at the contribution per unit. Thus, the calculation of contribution per unit is:
(Total revenues - Total variable costs) / Total units
The concept is useful for determining the minimum possible price at which to sell a product (never go below a contribution per unit of zero; you would otherwise lose money with every sale). The only conceivable reason for selling at a price that generates a negative contribution margin is to deny a sale to a competitor.
When only one product is being sold, the concept can also be used to estimate the number of units that must be sold so that a business can break even. For example, if a business has $10,000 of fixed costs and each unit sold generates a contribution margin of $5, then the company must sell 2,000 units in order to break even. However, if there are many products with different contribution margins, this analysis can be quite difficult to perform.
The key component of the contribution per unit calculation that can cause difficulty is the variable cost. This should only include those costs that vary directly with revenues. Thus, it should not include any overhead cost, and should rarely include direct labor costs. Typically, variable costs are only comprised of direct materials, any supplies that would not be consumed if the products were not manufactured, commissions, and piece rate wages.
As an example of contribution per unit, ABC International has generated $20,000 of revenues in the most recent accounting period from sales of its purple widget. There are $14,000 of variable costs associated with these revenues, which means that the overall contribution margin for the purple widget was $6,000. Since ABC sold 500 purple widgets, the contribution per unit was $12 (calculated as $6,000 contribution margin / 500 units sold).