You must recognize that the success of service and product-based businesses dramatically depends on their profit. To know whether your business is a profitable unit, you can check whether your production costs are lower than the cost of each product you are selling. By understanding how to calculate the cost per unit of a product, you can easily set the prices and attain your sales goals. Keep reading to know more about the cost per unit and how to calculate the unit per Price.
What is the Cost Per Unit
Cost per unit, also known as the cost of sales, cost unit, or the cost of products sold, is the total amount of money a business spends to produce a single unit of product. It also refers to both fixed and variable costs related to production. The cost per unit calculation generally shows in the financials statement. By calculating this, you can determine if its production costs are lower than the sales revenue. Besides, it can also help you to fix a reasonable price and generate profits.
Methods to Calculate Cost Per Unit
Want to know how to calculate the cost per unit of product? Well, a simple per-unit cost formula can be used. However, the procedure has four major components. Keep reading to understand more about those components.
The formula of Cost Per Unit
You need to consider the variable and fixed costs for cost per unit calculation. Then you need to divide the total variable and fixed cost by the total number of products produced during that particular period. The formula is:
Cost Per Unit= (Total Variable Costs + Total Fixed Cost) / Number of Units Manufactured.
However, to calculate cost per unit accurately, you will have to understand fixed and variable costs.
What Do You Mean by Fixed Cost?
Your total fixed costs will remain constant even if the production quantity is high or low in that period. Some best examples of fixed costs are overhead, salaries, rent, business insurance, property tax, and more. Combining all such fixed costs to find your total fixed cost. Even though fixed costs don't change drastically, there can be some situations where they may increase. It is called step cost. It generally happens when the production requirements increases and you need to rent more storage units or warehouses. In such a case, you should consider your new fixed costs.
What Do You Mean by Variable Costs?
In simple words, variable costs are the expenses that can change based on the total output and the costs change frequently. It can change quarterly, monthly, yearly, and daily. Some examples are advertising fees, material costs, labor costs, utility bills, maintenance costs, shipping costs, costs of packaging, and more.
Example of Cost Per Unit Calculation
Here is a simple example of cost per unit calculation that will make it easy to understand. XYZ firm has a fixed cost of USD 50,000 and a variable cost of USD 80,000 in October 2022. They manufactured 13,000 widgets. Here the cost per unit will be:
(USD 50,000 + USD 80,000) / 13,000 widgets = USD 10 cost per unit.
In November, the firm manufactured 20,000 units, and the variable and fixed costs were USD 100,000 and USD 70,0000, respectively. In this case, the cost per unit is:
(USD 70,000 + USD 100,000) / 20,000 units= USD 8.5 cost per unit.
Now, if the firm wants to set a 10 percent profit margin, they must fix the widget's selling price accordingly. For example:
Selling Price = Cost Per Unit + Profit Margin
USD 8.5 + (10% of USD 8.5) = USD 16.5
So, to make a profit, the firm should sell the widgets at USD 16.5. Some companies go for a higher profit margin than 10 percent.
How To Use Cost Per Unit To Make Better Purchasing Decisions
As mentioned above, cost per unit is the per-unit expenses that a company incurs to manufacture goods and services. The Price per unit is the per-unit Price that a company charges from the customer against the products sold. And the difference between the Price and cost per unit is the profit per product piece earned by the company.
In general, based on the cost per unit, most businesses set the selling price of the product, keeping the profit in mind. If they said a price per unit without considering cost per unit, it might lead to a considerable loss. Besides, this can also help the customers come up with a better purchasing decision as they can know whether the Price charged is feasible. For example, if the cost per unit is USD 80 and the company charges USD 150 per unit, the customers may not purchase the product and will look for an alternative.
Benefits Of Calculating Cost Per Unit
The per unit cost formula establishes a relationship between gross profits, logistic costs, and production costs. For any business, it plays a vital role in its pricing strategy. It includes the cost of shipping and fulfillment, marketing, sales, supplier, manufacturing, and more. Besides, a lower per-unit price can indicate the presence of internal efficiencies.
It helps Ensuring Your Business Efficiency
The calculation of cost per unit gives a detailed insight into the total costs to manufacture a single item, store it, ship it, and more. This will also help you to detect the inefficiencies that are increasing the cost. If the per-unit cost is low, then it suggests efficient production and logistics. And that means you can make a profit per sale.
Plays an Important Role in Product Pricing
It is essential to calculate cost per unit as it offers an idea of how much you need to charge per product to generate profit.
Related: How to Calculate Beginning Inventory
Tips For Reducing The Cost Of Goods And Services
If the cost per unit calculation shows a high cost per unit, the product needs to be priced higher so that the company can attain the desired profit. Many businesses use different ways to motivate their customers to spend more money on a product. For example, they are offering cash back, discounts, and other incentives. But such ideas may only sometimes work. Different factors can influence prices per unit, so it is possible to lower the variable and fixed costs of your goods and services. Some practical tips to consider for this are:
Lower the Overhead Cost
You can lower the overall overhead costs by finding an area with affordable rent and lease. Consider leasing your workspace during a recession and assess your service charges. Increasing your sales is also a great way to lower the prices per unit. But this is only sometimes possible.
It's Time to Optimize the Logistic Strategy
Your cost-per-unit calculation includes the cost of logistics. So, if you can lower your logistic cost, you can reduce the cost per good and service. As per the experts, you are improving your supply chain's efficiency, making it possible to lower storage costs, first-mile delivery, and fulfillment costs. The first-mile delivery cost can be reduced by lowering the distance between distribution centers and suppliers. On the other hand, by working with a professional 3PL or automating the fulfillment process, you can reduce the fulfillment cost. With this, you provide your customers with the products at the best prices while maintaining the competitiveness of the pricing.
Lower The Cost of Material
To calculate the cost per unit, you must also consider your material cost. And it is possible to lower material acquisition costs. How? For this, you can optimize your product sourcing. Work with a supplier located near your location or a low-cost manufacturer.
On the other hand, you also need to evaluate the freight shipping and logistic procurement costs to ensure that your products and services are available at the lowest prices. For instance, a professional wholesale distributor can offer attractive rates for inventory replenishment. Remember that wholesalers or suppliers need a minimum order quantity per inventory. However, if you can invest more in your inventory upfront, the chances of getting discounts will be more.
Lower Returns, Reshipment and Dead Stock
Deadstock and product returns can increase logistic costs. And this, in turn, will increase your cost per unit. You can use professional inventor forecasting tools to ensure there is no overstock. And ensure that the process fulfillment is efficient and can offer a higher order accuracy.
You can use an online unit cost calculator or the above-mentioned per unit cost formula to calculate your cost per unit. If you think it is high, don't worry, and use the tips listed here to lower your cost per unit and make a profit. One of the best ways to reduce the cost per unit is by partnering with a professional 3PL service provider who can handle your products' storage, distribution, fulfillment, and transport requirements. Don't hesitate to contact us if you need help fulfilling orders for your eCommerce business. We're here to help you succeed!