UNIT COST: WHAT IT CONSISTS OF, HOW IT IS CALCULATED AND EXAMPLES - DUDAS - 2025

The unit cost is the total expenditure incurred by a company for producing, storing and selling one unit of a product or service in particular. It is a synonym for the cost of merchandise sold and the cost of sales.

It is a measure of the cost of a business to build or create a unit of product. This accounting measure includes all fixed and variable costs associated with the production of a good or service.

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Knowing the unit cost helps business owners determine when they will start to make a profit, helping to price products with that in mind. Provides a dynamic overview of revenue, cost, and profit relationships.

However, typical fixed and variable costs differ widely across industries. For this reason, making the breakeven comparison is generally more eloquent between companies within the same industry. Defining a breakeven point as "high" or "low" must be done within this environment.

What is the unit cost?

Unit cost is a crucial cost measure in the operational analysis of a company. Identifying and analyzing the unit costs of a company is a quick way to verify if a company is producing a product efficiently.

Variable and fixed unit costs

Successful companies look for ways to improve the overall unit cost of their products by managing fixed and variable costs. Fixed costs are production expenses that do not depend on the volume of units produced.

Some examples are rental, insurance, and use of equipment. Fixed costs, such as storage and use of production equipment, can be managed through long-term rental contracts.

Variable costs vary depending on the level of production produced. These expenses are further divided into specific categories, such as direct labor costs and direct materials costs.

Direct labor costs are the wages paid to those directly involved in production, while direct material costs are the cost of materials purchased and used in production.

Supplying materials can improve variable costs from the cheapest supplier or outsource the production process to a more efficient manufacturer. For example, Apple outsources its iPhone production to Foxconn of China.

Unit cost and equilibrium analysis

The unit cost of a company is a simple measure to calculate profitability. If the unit cost, including fixed and variable expenses, is calculated as $ 5.00 per unit, selling a unit for $ 6.00 generates a profit of $ 1.00 for each sale.

A selling price of $ 4.00 creates a loss of $ 1.00, although this analysis does not accurately capture all market activity.

For example, a product has a profitable price of $ 7.25. If this product is not sold, it will create a loss. The loss will be in its unit cost value of $ 5.00, and perhaps also in additional costs for the return shipping and disposal.

Revaluing it at $ 4.00 can result in a cost per loss of $ 1.00 per unit, but if the product is sold at this price, a greater loss can be avoided.

How is it calculated?

Unit cost is commonly derived when a company produces a large number of identical products. This information is then compared with the budgeted or standard cost information to see if the organization is profitably producing goods.

The unit cost is generated from the variable and fixed costs incurred by a production process, divided by the number of units produced. The calculation of the unit cost is:

(Total fixed costs + Total variable costs) / Total units produced.

The unit cost should decrease as the number of units produced increases, mainly because the total fixed costs will be spread over a larger number of units. Therefore, the unit cost is not constant.

For example, Company ABC has in May total variable costs of $ 50,000 and total fixed costs of $ 30,000, which it incurred while producing 10,000 devices. The cost per unit is:

($ 30,000 + $ 50,000) / 10,000 units = $ 8 unit cost.

In the following month, ABC produces 5,000 units at a variable cost of $ 25,000 and the same fixed cost of $ 30,000. The unit cost is:

($ 30,000 + $ 25,000) / 5,000 units = $ 11 unit cost.

Variants in the formula

In management accounting, it is common to ignore fixed costs when calculating unit cost, as fixed costs may be outside the control of operations, and the main concern is evaluating production efficiency.

For example, if a business purchases new IT equipment to streamline sales and administrative functions, including these capital purchases in the unit cost formula will increase the overall unit cost.

From the overall financial perspective of the company, this may be accurate, but it does not reflect the efficiency of production during the period in which the capital purchase is made.

This variation in unit cost is often referred to as the cost of merchandise sold. Typically generated for internal use within a company.

Examples

ABC Company

Suppose that it costs Company ABC $ 10,000 to buy 5,000 items that it will sell at its outlets. The unit cost of company ABC will then be: $ 10,000 / 5,000 = $ 2 per unit.

Calculating unit cost is often not that simple, especially in manufacturing situations.

Typically, unit costs involve having variable costs, which are costs that vary with the number of units manufactured, and fixed costs, which are costs that do not vary with the number of units manufactured.

Restaurant XYZ

At Restaurant XYZ, which sells only pepperoni pizza, the variable expenses for each pizza sold can be:

- Flour: $ 0.50.

- Yeast: $ 0.05.

- Water: $ 0.01.

- Cheese: $ 3.00.

- Pepperoni: $ 2.00.

- Total: $ 5.56 per pizza.

On the other hand, the monthly fixed expenses that Restaurant XYZ has to pay can be:

- Labor salaries: $ 1,500.

- Rent: $ 3,000.

- Insurance: $ 200.

- Advertising: $ 500.

- Utilities: $ 450.

- Total: $ 5,650.

If Restaurant XYZ sells 10,000 pizzas per month, then the unit cost of each pizza would be: Unit cost = $ 5.56 + ($ 5,650 / 10,000) = $ 6.125

References

1. Investing Answers (2019). Unit Cost. Taken from: investinganswers.com.
2. Julie Young (2019). Unit Cost. Investopedia. Taken from: investopedia.com.
3. Steven Bragg (2018). How to calculate cost per unit. AccountingTools. Taken from: accountingtools.com.
4. Study (2019). Unit Cost: Definition, Formula & Calculation. Taken from: study.com.
5. Scott Shpak (2018). How to Determine the Unit Costs of Production. Small Business - Chron. Taken from: smallbusiness.chron.com.