Understanding Contribution to Cover Fixed Costs
- Jojo is running a small café.
- Jojo sells each cup of coffee for \$5, and it costs \$2 to make one cup.
- The difference between these two amounts, \$3, is what helps Jojo pay for fixed costs, like rent and salaries.
This difference is called contribution.
Contribution
Contribution is the amount of money left after subtracting variable costs from sales revenue. It helps cover fixed costs and, once those are covered, contributes to profit.
Contribution Per Unit
Contribution per unit
Contribution per unit tells you how much each unit sold contributes to covering fixed costs.
Contribution per unit is a key metric for understanding how much each sale helps your business move closer to profitability.
Formula
The formula for contribution per unit is:
$$\text{Contribution per Unit} = \text{Selling Price per Unit} - \text{Variable Cost per Unit}$$
Example- Suppose you sell a product for \$20, and the variable cost per unit is \$8. The contribution per unit would be:$$\text{Contribution per Unit} = \$20 - \$8 = \$12$$
- This means each unit sold contributes \$12 towards covering fixed costs.
Think of contribution per unit as the "leftover" money from each sale that helps cover your fixed expenses.
Total Contribution
While contribution per unit focuses on a single unit, total contribution looks at the overall contribution from all units sold.
Formula
The formula for total contribution is:
$$\text{Total Contribution} = \text{Contribution per Unit} \times \text{Quantity Sold}$$
Example- Using the previous example, if you sell 500 units, the total contribution would be: $$\text{Total Contribution} = \$12 \times 500 = \$6,000$$
- This \$6,000 goes towards covering fixed costs.
- Any amount beyond the fixed costs becomes profit.
