# What is Variable Contribution Margin?

## Variable Contribution Margin

The Variable Contribution Margin refers to the revenue remaining per unit after subtracting the variable costs that go into producing a product. In other words, it is the contribution each unit of a product makes to cover fixed costs and generate profit. This metric is particularly useful for understanding the profitability of individual items sold by a business.

The formula for calculating the Variable Contribution Margin per unit is:

Variable Contribution Margin per Unit = Selling Price per Unit − Variable Cost per Unit

The Variable Contribution Margin Ratio, expressed as a percentage, is calculated as follows:

Variable Contribution Margin Ratio = (Variable Contribution Margin per Unit / Selling Price per Unit) × 100

Importance of Variable Contribution Margin:

• Profitability Analysis: It helps businesses determine the profitability of individual products.
• Pricing Strategies: Understanding the contribution margin can help in setting the right pricing strategies.
• Break-Even Analysis: It is crucial for calculating the break-even point, i.e., the point at which total revenue equals total costs.
• Cost Control: Identifying the variable costs associated with production can lead to cost-saving measures.
• Resource Allocation: Businesses can focus resources on products with higher contribution margins to maximize profitability.

## Example of Variable Contribution Margin

Let’s delve into an example that illustrates the concept of Variable Contribution Margin using a fictional bakery called “Sweet Treats.”

Sweet Treats offers a variety of baked goods but is especially known for its chocolate chip cookies. The bakery is trying to optimize its operations and wants to understand how profitable its cookies are.

• Selling Price: \$2.00
• Variable Costs (flour, sugar, chocolate chips, labor): \$0.80

Calculating the Variable Contribution Margin:

• Variable Contribution Margin per Cookie:
\$2.00 – \$0.80 = \$1.20
Each cookie contributes \$1.20 towards covering the fixed costs and generating a profit.
• Variable Contribution Margin Ratio:
(Variable Contribution Margin per Cookie / Selling Price per Cookie) × 100
(1.20 / 2.00) × 100 = 60%

Interpretation:

• Profitability: The Variable Contribution Margin of \$1.20 per cookie indicates that this amount can go towards covering fixed costs like rent, utilities, and salaries, as well as generating profit for the business.
• Margin Ratio: A Variable Contribution Margin Ratio of 60% means that 60% of the revenue from each cookie sale can be used to cover fixed costs and generate profit.

Understanding that each cookie has a Variable Contribution Margin of \$1.20 and a Margin Ratio of 60% can guide Sweet Treats in several ways:

• Pricing Strategy: If the bakery wants to offer a discount to attract more customers, knowing the Variable Contribution Margin ensures they don’t set a selling price that falls below the variable costs.
• Promotions: During special events, Sweet Treats can focus on marketing the cookies, knowing they have a high contribution margin.
• Cost Control: Understanding that the variable cost per cookie is \$0.80 can help in negotiating better deals with suppliers or optimizing production to bring this cost down, thereby increasing the contribution margin.
• Resource Allocation: Knowing the contribution margin can guide the bakery on where to allocate resources, perhaps favoring cookies over less profitable items.

This example demonstrates how Variable Contribution Margin is a useful metric in business decision-making, helping to focus efforts on the most profitable activities and make informed pricing and promotional strategies.