- Cost per unit = (Total fixed costs + Total variable costs) / Total units produced.
- Total fixed cost = Building rent + Direct labor costs + Other fixed costs.
- Total variable cost = Production costs + Customer acquisition costs + Packaging costs + Shipping costs + Other variable costs.
Managerial Accounting: Calculate Total, Prime, and Conversion Cost Per Unit
Why is cost per unit important?
Cost per unit is crucial because it can help you determine how effective and successful your business is, allowing you to take the necessary corrective action if necessary. Cost per unit aids in determining the price you should charge for each product to ensure profitability. For your business to be profitable, your cost per unit must be lower than the price you charge each customer for a unit.
Because a profitable cost per unit is essential to the success of a business, this analysis is typically performed by a person or group who looks for opportunities to cut costs or minimize the risk of incurring new or higher expenses. More profit is possible the lower the cost of production.
For instance, if the cost of a hat you sell is $10 per unit, you could sell each one to customers for $25 and make a profit of $15 on each one.
What is cost per unit?
Many product-based businesses, from smaller local shops to large corporations, calculate their cost per unit. A cost per unit can be used by service-based businesses as well, but the calculation is typically a little more complicated. The amount of money spent by a company to produce one unit of the product they sell is known as the cost per unit, also known as the cost of goods sold or the cost of sales. Companies include this figure on their financial statement.
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
The costs known as “fixed costs” are those that never change. Your fixed costs are unrelated to your unit production, so they will remain constant regardless of how many units you produce or how much demand there is. Office rent, business insurance, employee salaries and benefits, equipment rental, and property taxes are examples of fixed costs. This isnt an exhaustive list of possible fixed costs. Keep in mind that every business is unique, and that different factors can affect the fixed costs.
Step costs occur when a fixed cost rises as a result of a rise in production requirements. This could happen if a computer manufacturer needs to rent more warehouse space in order to fulfill orders. In this case, you would need to determine a new fixed cost to take into account this additional expense. Aside from these kinds of situations, fixed costs shouldn’t vary significantly from one production to the next.
2. Identify your variable costs
Variable costs are the costs that may change regularly. This variation can occur on a daily, monthly, quarterly, annual, or even between production time basis. Variable costs, in contrast to fixed costs, are determined by the quantity of units produced, and they can vary from one calculation to the next. Direct labor costs, or how much you pay hourly or contract workers to create the product, and direct material costs, or how much you spend on the materials you need to make your product, are added together to form the variable costs.
For instance, if your business produces labels for spice jars, you might have a worker operating the equipment that converts the final design to a unique printed paper that is attached to the jar. Over time, as they create their own system for finishing their work, that employee will become more productive. Whereas initially producing 100 labels per day, the employee may eventually increase that production to 200 labels per day. Your variable costs are actually lower because you continue to pay this employee the same hourly wage while receiving greater output.
Items like employee hourly pay, the cost of purchasing materials for your product, credit card processing fees, advertising costs, and utility bills are examples of variable costs.
Business owners and managers may look for a more cost-effective manufacturer or a materials supplier in an effort to reduce their total variable cost per unit.
3. Know how many units youre producing
The number of units you are producing is the last figure you need for the cost per unit calculation. As an illustration, if you produce 100 candles each month, your unit number is 100. This could be the number of units you produce each month or every three months, or you could determine the cost per unit based on the volume of units produced during a specific production period. Remember that all measurements should be made using the same units of measurement, so if you use unit numbers on a monthly basis, your fixed and variable costs should be, too.
4. Insert your fixed cost, variable cost and number of units into the formula
You must add up all of your fixed and variable costs and divide that total by the number of units you produce in order to calculate your cost per unit. The cost per unit calculation is:
Cost per unit is calculated as (total fixed costs plus total variable costs) / the number of units produced.
The price per unit refers to more than just the cost of producing one unit of your product. It also serves as your breakeven point, or the price at which you must sell the product in order to break even.
To make money, you must sell each unit of your product for more than $50, for instance, if the cost per unit for your product is $50. You make $5 in profit per unit if you sell your product for $55 per unit. But if you charge $45 for each unit of your product, you lose $5 on each one that is sold.
Particularly at larger businesses, you might find an entire team devoted to market research, selecting a fair price point for the product, and using cost per unit to ensure the business is turning a profit on each sale. Businesses succeed when they continually assess their fixed and variable costs and look for ways to reduce them to lower the overall cost per unit.
Example of cost per unit calculation
Here is an example of a cost per unit calculation:
A company called Touring The Road makes and sells bicycles to consumers. For a group of 100 bicycles for the month, they might hire a designer for $300 to come up with the colors and style for each bike and a manufacturer for $1,000 to make the bicycles and any accompanying clothing. The variable cost in this condensed example is $300 plus $1,000, for a total of $1,300.
Then, they may incur fixed expenses such as $500 in monthly rent for their office space and $120 in monthly business insurance, for a total of $620 in fixed expenses. With these figures, the total expense amount is $1,920. Your cost per unit, or cost per bicycle, is $19 if you divide this expense amount of $1,920 by the 100 bicycles you are manufacturing. 20. According to this calculation, each bike needs to be sold for more than $19. 20 to make a profit.
Accounting for unit costs
Unit cost is typically found on financial reporting statements because GAAP, or generally accepted accounting principles, is the reporting standard used by all publicly traded companies. This allows the company to compare costs and revenues. Businesses that sell products record the unit cost on their inventory sheet, record sales on the income statement, and calculate gross profit.
Gross profit is the amount of money a business makes after deducting the cost of producing each unit. Companies look at two numbers to gauge how effective and profitable their production is: gross profit and the percentage increase from unit cost to unit sale price.
