The unit cost or unit cost is the monetary value of producing a good or a service. It is usually calculated as the cost of producing all goods divided by the number of goods produced.
It is essential in business to know how much is the unit cost of what it costs to produce a good, because that will have a direct impact on the price of the final product and probably on the customer’s decision to purchase it.
How to calculate the unit cost of a product or service
To calculate the unit cost, the sum of fixed and variable costs, divided by the quantity of goods produced, are taken into account.
To fully understand what charges should be included in the calculation of this cost, let’s first understand what fixed costs and variable costs refer to:
- Fixed Costs: They are all those that are paid constantly, generally on a monthly basis and that are independent of the number of products produced. For example, the lease of a premises, electricity, drinking water, internet, fire insurance, and base salaries of employees.
- Variable Costs: Are all those costs that increase depending on the amount of products that are manufactured. For example, flour, because the more bread is produced, the more flour is consumed. We can also find the sales commissions of the employees, because the greater the number of sales, their salary increases by a percentage. This last case is called "semi-variable cost" in accounting, because it has a fixed and a variable component.
However, there are also other "expenses" that can be included, such as the so-called "GAV", or Administration and Sales Expenses, which are not considered Costs, since they do not have a direct return, or the expense of resources does not represent necessarily an investment.
An example of GAV is what the company spends on printing invoices, buying pencils, ink for printers, flavorings for the sales room, etc. Expenses that are of the business and that indirectly affect the sale of the products. It is suggested that a percentage be assigned to these expenses and also charged in the Total Cost.
Example of unit cost calculation
Suppose that an entrepreneur owns a bakery and does not know at what price to sell a piece of his best cake. The only thing his accountant managed to tell him before going on vacation was to sell it at 30% over the total cost.
The entrepreneur broke down his Total Costs as follows, considering what he paid in the last month:
- Lease of the premises 1000 USD
- Base Employee Compensation $ 1,000
- Electric power 100 USD
- Water 100 USD
Total fixed costs 2,200 USD
The entrepreneur took the previous month as a reference and realized that to produce 200 cakes, he needed 200 biscuits, 100 jars of chocolate cream and 100 bags of jam, with the prices of each product being 4 USD.
For what you spent:
- 800 USD in cupcakes.
- 400 USD in chocolate cream.
- 400 USD in bags of jam.
Variable costs of the month for 200 cakes 1,600 USD
In GAV it recorded a cost of 200 USD.
So the total cost is: CF 2200 + CV 1600 + GAV 200 USD = 4,000 USD
If we divide between the 200 cakes that were produced in the month:
Unit cost = $ 4,000 / 200 = $ 20 per cake.
So $ 20 is the unit cost of producing one cake , based on the costs for 200 cakes.
To calculate the price that the commercial wants to charge, he adds the 30% margin :
Cake price = 20 x 1.3 = 26 USD.