All businesses want to make a profit. It is vital, therefore, for management to understand how the company is making a profit — or why it is not. A per-unit analysis of gross profit margin and contribution margin can provide crucial information about which products and product lines are making the most money for the business, and which are performing poorly. Carefully observe and react to these margins and managers can be prepared for a happy return at the end of the year.
Gross Profit Margin Per Unit
Calculate Units Sold
Determine how many units you sold during the analysis period. If you are planning in advance, use your planned sales, or simply one unit. Let us assume Company ABC sold 10,000 units.
Find Revenue Per Unit
Divide the total sales revenue for all units by the number of units sold to get revenue per unit. If you are calculating projections based on one unit, this is your average retail price. Do not forget to factor discounts and damages into your projections: If you believe you will discount and write off 10% of your retail price on average, deduct this from your projected revenue per unit.
Let us assume Company ABC made $32,000 in gross sales revenue. Damaged or returned items represented 5% of the total sales population, amounting to $1,600. Sales revenue is therefore $30,400. For 10,000 units, that amounts to revenue per unit of $3.04.
Revenue per unit = Total sales revenue / Number of units sold
Add Production Costs
Add up the costs of producing these units. If you purchased this item wholesale and resold it, this cost is your purchase price. If you manufactured the unit, it is the cost of supplies, labor and resources that went into its production. Only include items that directly relate to unit manufacture — if your employee makes 10 widgets per hour and gets paid $15 for that hour, the direct labor cost per widget is $1.50.
In our example, Company ABC bought the items wholesale at a cost of $15,000 for 10,000 units.
Find Gross Profit Per Unit
Divide your costs by the number of units they represent to get cost per unit. Then subtract your production cost per unit from your revenue per unit for the gross profit per unit. Divide this number by your revenue to express your profit margin as a percentage of revenue. Here's how it works for Company ABC:
Total costs / number of units = cost per unit
$15,000 / 10,000 = $1.50
Revenue per unit - production cost per unit = gross profit per unit
$3.04 - $1.50 = $1.54
Gross profit per unit / revenue per unit = profit margin
$1.54/$3.04 = 0.506, or 50.6 percent.
Calculating the Contribution Margin Per Unit
The contribution margin takes into account the variable costs of selling the unit, rather than ending consideration at manufacturing.
Calculate Revenue Per Unit
Calculate your revenue per unit as described in Steps 1 and 2 of the previous section.
Determine Selling Costs
Identify all costs related to selling each unit. This includes marketing, advertising and salesperson salaries. Find the sum and divide by the number of units to get selling cost per unit.
Find Total Cost Per Unit
Add your selling costs per unit to the production cost per unit as calculated in Step 3 of the previous section to determine your total cost per unit.
Find Contribution Margin Per Unit
Subtract your total cost per unit from your revenue per unit to get your contribution margin per unit. Divide this number by your revenue per unit to express it as a percentage of revenue.
You can use these same methods to evaluate various product or business lines — just group your numbers accordingly. Do not forget to include volume in your profit analysis. Your highest margins are worth nothing if you are not moving any units.
Nola Moore is a writer and editor based in Los Angeles, Calif. She has more than 20 years of experience working in and writing about finance and small business. She has a Bachelor of Science in retail merchandising. Her clients include The Motley Fool, Proctor and Gamble and NYSE Euronext.