Break-Even Point Analysis
Contribution Margin
Contribution margin is the portion of revenue that is not consumed by variable cost. In a simple example, if you were to buy a candy bar for 75 cents and resell it for $1, then the contribution margin would be 25 cents - the amount not consumed by cost.
Of course, in business this is generally more complicated. It requires you to understand the variable costs for an item, or those costs that are directly tied to producing a new unit. When selling lemonade from a stand, the costs of the water, lemon juice, sweetener, ice, and serving glass are all variable costs that will recur with each item sold. The cost of the stand is a fixed cost. The labor required to make and serve the lemonade is also generally a fixed cost, as it doesn't vary based on the number of glasses sold. Let's look at this in numeric terms, as follows:
| Inputs | Cost | Variable or Fixed? |
|---|---|---|
| Lemons, sweetener, ice, and water | 20 cents per glass | Variable |
| Glasses | 5 cents each | Variable |
| Labor | $100 per day per employee | Fixed |
| Lemonade stand rental | $2,000 per month | Fixed |
If we know that the stand sells 1,000 glasses of lemonade each day at $3 per glass, and that one employee can make and serve 1,000 glasses, then we can calculate the contribution margin.
The cost of raw materials is 25 cents per glass (20 for ingredients + 5 for the glass). If the lemonade is sold for $3 per glass, then the contribution margin is $2.75 per glass.
It's important to know the contribution margin in order to calculate what portion of the revenue from a product is consumed by the variable costs and what portion can be used to cover, or contribute to, fixed costs.