Unit costs in business
What are unit costs in business?
The unit cost is the expense incurred by a business to produce, store and sell a single product. The unit cost is also known as average cost, product cost or single cost. The unit cost is typically calculated when a business produces a large volume of identical products. Unit costs include all costs (fixed and variable) and is calculated for both goods and service products.
Why does a business calculate unit costs?
Costs in business are typically paid for in lump sums like bulk materials, weekly wages and monthly rent. However a business typically sells its products as units. So for a business to ensure that it is making the appropriate profit margin on the products it sells, the business needs to calculate the unit cost of each product. That is, the profit for each product equals the product selling price minus the unit cost of the product.
Once a unit cost has been calculated as a key performance indicator (KPI) in monetary and % terms, it can then be compared to the budget, previous periods and industry benchmarks to identify any under/over performance of the costs and profitability of the product. Given this information on an ongoing bases, managers and business owners are then able to implement strategies to mitigate problems identified or exploit the identified opportunities with the product.
What are the components of a unit costs in business?
To calculate the unit cost of products sold in a business, you will need to first gather information about all the costs associated with the production of a specific volume of identical products. Now costs can be grouped by their particular behaviour in the production process. i.e. Fixed and Variable costs
- Fixed costs are those costs that do not change in relation to changes in business activity like production. A good example of a fixed cost is rent that is paid monthly and is not impacted by a change in volume of products produced.
- Variable costs are those costs that do change in proportion to changes in business activity like production. i.e. if units of production doubles, then the variable costs will double as well. A good example of a variable costs is direct materials (materials used in the production of the product)
So the unit cost of 10,000 units produced costing $20,000 in total fixed costs and $30,000 in total variable costs would be:
Unit cost = (Total fixed costs + Total variable costs) ÷ Total units produced
Unit cost = ($20,000 + $30,000) ÷ 10,000
Unit cost = $5.00
What are unit costs like?
Unit costs in business is like calculating how much each person on the sports team must pay in order to hire a bus to transport them to a game. If the total cost of transporting the team to the game cost $300, the coach would need to work out how much each of the 30 team members must pay to cover this cost. So the coach would divide the total cost ($300) by the number of team members (30) to calculate a unit cost of $10. The unit cost of transporting the team to the game would then be $10 per team member.
How do unit costs impact on a business?
Unit costs impact on the profitability of products which collectively impacts of the profitability and financial sustainability of a business. If unit costs increase without a corresponding increase in selling prices, then the profitability of a product will diminish. Changes in unit costs directly impact the Gross Profit % of a business. Business managers need to constantly monitor the changes in unit costs and respond with increased selling prices otherwise the Gross Profit that the business achieves on that product will be reduced, impacting the overall profitability of the business.
When does a business calculate unit costs and who is typically involved?
Unit costs are typically calculated just before a business sets their selling prices for products. Most businesses have a view about the sort of gross profit margins they need to achieve in order to be profitable and financially sustainable. This view may have come from operating a similar business, from government tax information or from industry associations.
Having the unit cost together with the targeted gross profit %, a business is able to calculate the selling price using the formula: Unit Selling Price = Unit cost / (1 – Gross Profit %).Unit costs would generally be undertaken by an accountant (internal or external) or a business owner who has had previous experience in this field.
What key terms relate to unit costs in business?
- Products: A product is an item (goods) or a service that is offered by a business to satisfy the desire or need of a customer. It may be in physical or virtual form. Products cost the business to initially make or purchase but they are then sold to customer at a profit.
- Fixed costs: A fixed costs are business ex
penses that remains largely unchanged in relation to changes in business activity, output or sales. Examples include rent, depreciation, insurance and managerial salaries.
- Variable costs: Variable costs are business expenses that do change in proportion to business activity, output or sales. Examples include customer delivery, cost of good sold and packaging.
- Selling price: Selling prices is the final price of a product or service that a business charges a customer to buy the item or service. It is the agreed exchange value that the buyer will pay the seller.
- Gross profit margins: Gross profit margin is the amount of money remaining for the business after deducting the cost of goods sold from the revenue. Gross margin is often expressed as a percentage and calculated by dividing the gross profit $ by the revenue.
Where can I find more information about of unit costs for business?
Unit Cost: Investopedia is an online platform that helps people understand complex financial concepts, improve their investing skills, and learn how to manage their money. This article provides a definition of unit costs, explains the breakdown and calculation of unit costs, explains fixed and variable costs, and unit cost’s importance to breakeven analysis.
Unit cost of production: Chron is an online newspaper that provides articles relating to business. It is based in Houston USA. This articles provides a definition, talks about fixed and variable costs, provides some tips and helps you calculate unit product costs and its relationship to break-even analysis.
How to calculate the unit cost: AccountingTools is an online website founded by Steven Bragg, CPA, and is the author of more than 100 business books and courses, including the best sellers Cost Accounting Fundamentals, The CFO Guidebook, Closing the Books, Payroll Management, and The GAAP Guidebook. This article gives you a step by step guide to calculating the unit cost.