Unit costs in business

Posted by SkillMaker in Dec, 2016

What are Unit costs?

The unit cost is the average total cost of making, storing and selling one unit of a product. It is a consideration when a business makes large numbers of the same product.
The unit cost of a product takes into account fixed costs as well as variable costs.
Fixed costs are not affected by variations in the production process (for example, rent, insurance and mortgage payments; taxes and so on). However, fixed costs may change on a regular basis (for example, insurance premiums may go up each year).
Variable costs change with the changing costs of a production run (for example, the costs of component parts, especially if these are imported and hence subject to currency fluctuations; direct costs of labour).
The unit cost of a product is worked out by calculating the total fixed and variable costs for a production run for that product and then dividing that figure by the number of products produced. The unit cost is the cost above which the product must be sold in order to make a profit. A business needs to always know this breakeven point. If a new production cycle for the same number of products sees an increase in production costs (and hence the unit cost), the selling price of the product will also need to increase if profitable operations are to be maintained.
Graphic

It is important that a business sets the true unit cost of a product carefully, in the interests of its ongoing financial viability. A unit cost that is too high may be a signal that it is not viable for the business to continue to offer it. Furthermore, if a business consistently sells products below unit cost, it will start operating at a loss.
Once the business is fully operational, actual unit costs should be compared with any estimated unit costs (which may have been set during a business start-up). If necessary, and to sustain profitability, some prices may need to be adjusted, or the mix of products offered by the business altered.

Additional resources

To find out more about unit costs, and calculating the breakeven point, view:
https://www.wrexham.gov.uk/assets/pdfs/business/se_manual/61_unit_cost_calcs.pdf