How to calculate contribution margin

• Per unit: one unit's selling price minus its variable cost.
• In total: sales for the period less total variable costs for the same period.
• As a ratio: total contribution divided by sales, showing what fraction of each sale survives the variable costs. Sales must be above zero.

The total and the ratio use the profit and loss figures for one period, rearranged by how each cost behaves; the per-unit figure uses a single item's price and cost. That remainder pays for fixed costs such as rent and insurance; profit begins only once they are met.

business.gov.au's glossary ties a variable cost to output and demand: it moves as production or customer demand moves. Its budgeting guide lists insurance, rent and car leases under fixed costs, with wages, utilities and supplies among the variable ones.

For a product business, the costs that usually rise with each extra sale include the goods or ingredients themselves, packaging, delivery, card and payment fees, and sales commission. Pay needs sorting person by person: a casual roster that grows on busy days goes with the variable costs, and a set salary goes with the fixed ones.

Catering brings in a sizeable share of sales but leaves the least towards fixed costs. Coffee leaves the most from each sale. On sales alone, catering sits close behind coffee; on contribution, it falls far behind both other lines.

business.gov.au's cash flow guidance suggests concentrating on the customers, products or services that earn you the most. Contribution by line is one way to find them.

The same month can be laid out by cost behaviour instead of by the usual profit and loss headings:

If every cost appears once, on one side or the other, the profit matches the profit and loss statement for the same month. If it doesn't, a cost has been left out or double counted.

Contribution per unit shows what a lower price does when the variable cost per unit is known. If that cost stays the same, the whole discount comes out of contribution, as in the example below. Recalculate any card fees or commissions that change with the selling price before comparing the results.

A discount that looks modest against the price can take away a large part of the contribution, so many more sales are needed just to stand still. If the discounted price is at or below the variable cost, there is no contribution left to divide by, and no number of extra sales makes up the difference. business.gov.au's pricing guide says discounts have an effect on your bottom line, and suggests confirming they still cover costs. It also describes pricing a line below cost to draw customers in and recovering the loss through other sales, and advises using that approach carefully.

• Mixed costs, such as a power bill with a fixed supply charge and a usage charge, need splitting before the figures mean much.
• Fixed costs can jump in steps. A second oven or another staff member changes the picture once demand passes a certain level.
• If capacity is the limit, contribution per hour of oven or staff time may matter more than contribution per sale.
• The ratio for the whole business shifts with the sales mix, so a month heavy in catering shows a lower ratio even if nothing else changed.

Dividing fixed costs by the contribution margin ratio, when that ratio is above zero, gives the sales needed to break even. The break-even guide works that through step by step.