Formula for Cost Per Unit Calculation (With Examples)
Cost Per Unit = (Total Fixed Costs + Total Variable Costs) / Total Units Produced
A successful business relies on being able to make a profit. For both product and service-based businesses, the cost per unit is a valuable calculation to make sure their costs are lower than what a unit sells for. Owners, managers and analysts work on adjusting the cost per unit to meet sales goals. In this article, we discuss what a cost per unit is, why it's important, how to calculate it and provide an example of a cost per unit calculation.
Read more: A Complete Guide To Economies of Scale
What is cost per unit?
Cost per unit is a calculation that many product-based businesses use, from smaller local stores to national corporations. Service-based businesses can use a cost per unit for their business too, but it is usually a little less straightforward of a calculation. Cost per unit, also referred to the cost of goods sold or the cost of sales, is how much money a company spends on producing one unit of the product they sell. Companies include this figure on their financial statement.
Why is cost per unit important?
Cost per unit is important because it can give you an idea of how efficient and successful your company is so you can take the steps to improve if needed. Cost per unit also helps you decide what to charge for each product so you can be sure you're making a profit. To be profitable, your company should have a cost per unit that is lower than what you're selling each unit for to your customer.
Because the success of the business relies on a profitable cost per unit, there is usually an individual or team that analyzes the factors involved in calculating the cost per unit to come up with ways to reduce costs or avoid the risk of new or increased expenses. The lower the production cost, the more profit you can expect.
For example, if the cost per unit for a hat you sell is $10, you can sell each one to your customers for $25, making a $15 profit per unit.
How to calculate cost per unit
There are four main parts of calculating cost per unit. The steps involved include:
1. Determine your fixed costs
Fixed costs are the costs that remain the same over time. Fixed costs are independent of your unit production, meaning that no matter how many units you produce or how much demand you have, your fixed cost will stay. Fixed cost includes items like office space rent, business insurance, employees' annual salaries and benefits, equipment rental and property taxes. This isn't an exhaustive list of possible fixed costs. Remember that each company is different and what contributes to the fixed cost can differ too.
Step cost is when a fixed cost increases because of an increase in production needs. This can happen in the case of a computer manufacturer who needs to rent additional warehouse space to be able to fill their orders. In this situation, you would need to calculate a new fixed cost that would account for this added expense. Other than these types of instances, fixed costs should not change too drastically from one production to the next.
2. Identify your variable costs
Variable costs are the costs that may change regularly. This change can happen from day to day, month to month, quarterly, yearly or even change between production times. Unlike fixed costs, variable costs depend on the number of units you produce, and it can change from one calculation to the next. The variable costs is the sum of both direct labor costs, or how much you are spending to pay hourly or freelance employees to help make the product, and direct material costs, or how much you spend on the materials you need for your product.
For example, if your company creates labels for spice jars, you could have an employee operating the machinery that translates the final design to a special printed paper that attaches to the jar. That employee will increase their productivity over time as they develop their own system for completing their work. Where that employee may start off by producing 100 labels per day, they can grow to produce 200 labels per day. Because your hourly pay for this employee remains the same, your variable cost is actually lower because you're paying the same amount yet receiving more output.
Variable cost includes items like hourly pay for employees, cost of purchasing materials for your product, credit card fees, advertising costs and utility bills.
Business owners and managers may seek to lower their total variable cost per unit by using a more efficient manufacturer or finding a materials supplier who charges less.
Read more: What Is Variable Cost? (With Examples)
3. Know how many units you're producing
The final number you need for the cost per unit calculation is the number of units you're producing. For example, if you are making 100 candles every month, your unit number is 100. This could be the units you produce every month or quarter or you can calculate the cost per unit based on how many units you produce in a given production period. Keep in mind that all units of measurement should remain the same, so if you use unit numbers on a monthly basis, your fixed and variable costs should be on a monthly basis too.
4. Insert your fixed cost, variable cost and number of units into the formula
To complete a cost per unit calculation, you must add up your fixed and variable expenses and divide that sum by the number of units you produce. The cost per unit calculation is:
Cost Per Unit = (Total Fixed Costs + Total Variable Costs) / Total Units Produced
The cost per unit means more than how much it costs to produce a single unit of your product. It also represents your breakeven point, or the minimum you must sell the item at before you can start making a profit.
For example, if your product's cost per unit is $50, your breakeven price is $50 and therefore, you must sell each unit of your product for more than $50 to make money. If you sell your product for $55 per unit, you make $5 of profit per unit. However, if you sell your product for $45 per unit, you are losing $5 per unit sold.
Especially at larger companies, you may find an entire team dedicated to analyzing the market and determining a good price point to sell the product at, then using the cost per unit to make sure the company is making a profit on each sale. Companies find success by continuously evaluating both the fixed and variable costs and finding ways to improve them to lower the total cost per unit.
Example of cost per unit calculation
Here is an example of a cost per unit calculation:
Touring The Road is a company that produces and sells bicycles to customers. For a group of 100 bicycles for the month, they may hire a designer for $300 to create the colors of each bike for and determine how it'll look and a manufacturer for $1,000 to create the bikes and associated apparel. In this simplified example, the variable cost is $300 + $1,000 for a total of $1,300.
They may then have fixed costs, including monthly rent of $500 for their office space and monthly business insurance of $120 for a total fixed cost of $620. With these figures, the total expense amount is $1,920. If you divide this expense amount of $1,920 by the 100 bicycles you're producing, your cost per unit, or cost per bicycle, is $19.20. Using this calculation, you must sell each bike for more than $19.20 to make a profit.
Accounting for unit costs
Since all public companies use a certain method of reporting called GAAP, or generally accepted accounting principles, you'll typically find unit cost on financial reporting statements so the business can compare costs to revenue. Product-based businesses include the unit cost on their inventory sheet, then record the sale on the income statement, resulting in gross profit.
Gross profit is how much money a company makes after taking into account the amount they spent to produce the unit. Gross profit, and the percentage increase from the unit cost to the unit sale price, are two figures that companies pay attention to when determining how efficient and successful their production is.
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