The unit cost calculation is especially useful for companies that produce or market a large number of the same item.
The unit cost serves as an input for other calculations such as the profit per unit, the comparison with the sale price, the breakeven point or simply to be compared with the budgeted cost and be considered for control purposes.
The unit cost calculation is derived from estimating fixed costs and variable costs for a business. Because the unit cost includes both administrative and general expenses of a fixed nature and direct costs of materials and labor, mostly variable or correlated to the level of production and sale.
Both production companies and marketers and service providers consider the calculation of unit cost as a way to measure their profitability levels, since achieving the lowest possible cost maximizes profits.
Thus, competitive companies seek to improve unit cost through efficient administration of fixed and variable costs. Let’s take a couple of minutes to define the concept of unit cost and how to calculate it.
What is the unit cost?
The unit cost is a measure of the total costs and expenses necessary to produce, protect, transport and sell a unit of product or service in particular.
The cost per unit derived from variable costs and fixed costs that are incurred in the production process and sales divided by the number of units produced.
The unit cost is not necessarily the retail cost of the item, it is much more comparable to an average cost. The selling price that equals the unit cost represents a breakeven point for a given item or service. So it translates into the minimum price at which an item can be sold so as not to generate losses.
The economy of scale allows a lower unit cost, since the total fixed costs are divided between a greater number of units resulting in a lower cost. During a certain interval of production and taking into account the marginal effect and the law of diminishing returns, the more that is produced, the lower the total cost per unit turns out .
The calculation of the unit cost is translated into a methodology to set the sale price. For example, if a company costs a total of USD 15 to produce and sell the finished article, it can set a selling price X% higher, such as 50%, to place its product on the market at USD 22.50, provided it is competitive.
How to calculate the unit cost?
We have said that the total cost is made up of the fixed and variable costs. The fixed costs do not change as production. Rent, utilities, and professional fees like the accountant and attorney are examples of fixed costs.
The variable costs are changed depending on how many units are produced and include raw materials, packaging and salary workers paid on time. The unit cost is based on the total of fixed costs and variable costs and on the number of units manufactured during a fiscal year.
Companies seek to manage their variable costs through a constant search for economy in raw materials, more efficient processes or outsourcing, that is, outsourcing production processes.
The cost per unit obeys the following formula:
Unit cost = (Total fixed costs + Total variable costs) / (Number of units produced)
Determine the total of your fixed costs by adding the total of the administrative and general expenses necessary to produce the product.
Calculate the total variable costs associated with current production. Total variable costs will increase as production increases and more products are manufactured. If production is low, so will total variable costs.
Add the fixed and variable costs to get the total cost of production.
Divide the total cost by the total number of units produced to get the unit cost.
For example, a manufacturer of vehicle brakes last month, totaled $ 50,000 in fixed costs and managed to produce 100,000 units of the best-selling part. The total variable costs amounted to USD 125,000, so the unit cost will be:
Unit cost = (50,000 in fixed costs + 125,000 in variable costs) / (100,000 pieces produced) = USD 1.75 per piece.