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Let’s understand each of the variables.
Fixed Cost per Order ($): The total cost you incur as a supplier to process an order, regardless of the ordered quantity.
Example: Truck rental costs. If you must hire a truck (to ship the order to the nearest transport hub) every time an order is shipped, no matter the quantity. A truck may charge $500 for a shipment, whether it carries 100 units or 1000 units.
Other examples of order-related fixed costs include paperwork, machine calibration, packaging line setup, etc.
Note: fixed costs here are exclusive of taxes like sales tax, GST, or VAT if these taxes are available as credit or are refundable. If not, these taxes should be part of the fixed costs.
Variable Cost per Unit ($): The direct costs of producing one unit. Examples include raw materials, direct labor, per-unit packaging costs, etc.
Note: variable costs here are exclusive of taxes like sales tax, GST, or VAT if these taxes are available as credit or are refundable. If not, these taxes should be part of the variable costs.
Selling Price per Unit ($): The price at which you plan to sell each unit to the buyer. This should not include taxes of any kind because these taxes aren’t your revenue. You simply collect and pass on the taxes to the government.
Minimum Order Quantity (MOQ): The minimum number of units you must sell in one order to break even or recover fixed costs per order. If ordered units (per order) are smaller than MOQ, you may lose money because fixed costs per order aren’t recovered.
Step 1: Calculate the contribution margin per unit
Contribution margin per unit = Selling price per unit - variable cost per unit
Contribution margin per unit = $10 - $4 = $6 per unit
Contribution margin per unit is the amount of money each unit contributes towards recovering fixed costs per order and then generating profit. If the contribution margin (in total) recovers fixed costs per order successfully, that means you’re generating profit at the order-level.
Step 2: Calculate the MOQ
MOQ = Fixed cost per order / contribution margin per unit
MOQ = $500 / $6 = 83 units