Original subtitles

Costs to a company can be split into two major groups;

fixed costs and variable costs.

Fixed costs are expenses that you will incur on a regular,

perhaps monthly basis, such as rent,

utilities, and employee salaries.

Variable costs are expenses that move up and down in response to production output.

This interpretation is particularly helpful for

companies to determine the pricing of the product.

In other words, it helps them find the breakeven point where

the pricing will cover fixed overhead costs for sure.

Contribution margin has one more important use.

It is a useful tool to dive into the P&L statement.

While the typical P&L statement line items tells

us the overall profitability of our business,

contribution margin can be used to identify

which product or product line is contributing the most to our profit margin.

If we want to perform this more detailed dive,

we want to compute the contribution margin per unit.

First of all, we want to calculate the overall contribution margin,

the difference between the sales revenue and for variable cost.

Recall that variable costs are expenses that

move up and down in response to production output,

such as cost of materials.

Once you get the difference for the total contribution margin,

you divide it by the unit sold and that gives you the contribution margin per unit.

You can think of the contribution margin as

a percentage of your revenue that'll cover your fixed costs,

which you have little control over and have to incur.

Any money left after fixed costs are taken from the contribution margin is your profit.

If the contribution margin per unit is less than the fixed cost,

this means you're making a loss on each sale.

So in other words, if you want to make a profit,

you have to sell your product with

at least your contribution margin covered for each unit sale.

Makes sense? Makes sure to process this slowly before proceeding.

We will calculate the contribution margin in the next video.