What is a 'Unit Cost'
A unit cost is the total expenditure incurred by a company to produce, store and sell one unit of a particular product or service. Unit costs include all fixed costs, or overhead costs, and all variable costs, or direct material costs and direct labor costs, involved in production. Determining the unit cost is a quick way to check if companies are efficient in producing their products.
BREAKING DOWN 'Unit Cost'
Unit cost is an important metric to look at when evaluating a "unit grower" stock, or a stock that chiefly produces items that have a low fixed cost. Generally, the larger a company grows, the lower the unit cost it can achieve through economies of scale.
Companies that produce products or provide services often look at unit costs as a way of measuring profitability. Being able to produce a product at the lowest cost possible should be the goal of all companies looking to profit. The unit cost is not necessarily the retail cost of the product being produced but rather the average cost of producing one unit of a particular item. The unit cost is sometimes referred to as the breakeven point, or minimum price, a company must sell the product to not incur losses. A product with a unit cost of $10 per unit may be sold to customers at twice the price, hence, gaining profit for the company.
Variable and Fixed Costs
Successful companies always look for ways to improve the overall unit cost of their products. This is done by managing the fixed and variable costs. Fixed costs are costs that go into producing a product and are not dependent on the volume of units produced. Examples are rent, insurance and salaries. Fixed costs such as warehouses and production equipment can be managed through long-term rental agreements.
Variable costs vary depending on the level of output produced. They are further divided into direct labor costs and direct material costs. Direct labor costs are the salaries paid to those who are directly involved in making the product, while direct material costs are the cost of materials purchased and used in making the product. Variable costs can be improved by sourcing materials from the best cost supplier or by outsourcing the production process to a more efficient manufacturer, such as Apple outsourcing its iPhone production to Foxconn of China.
Computing for the Unit Cost
Unit cost is determined by combining the variable costs and fixed costs and dividing by the number of total units produced.