What is '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 and labor costs. Determining the unit cost is a quick way to check if a company is producing a product efficiently.

BREAKING DOWN 'Unit Cost'

Unit cost is an important metric for evaluating a "unit grower" stock, or a stock that chiefly produces items that have a low fixed cost. Typically, the larger a company grows, the lower the unit cost of production because of economies of scale.

Companies that produce products or provide services often look at unit costs as a way of measuring profitability. Production at the lowest possible cost maximizes profits. The unit cost is not necessarily the retail cost of the product being produced, 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, at which a company must sell the product to avoid 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 seek ways to improve the overall unit cost of their products by managing the fixed and variable costs. Fixed costs are production expenses that are not dependent on the volume of units produced. Examples are rent, insurance and salaries. Fixed costs, such as warehousing and the use of 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 production while direct material costs are the cost of materials purchased and used in production. Variable costs can be improved by sourcing materials from the cheapest supplier or by outsourcing the production process to a more efficient manufacturer. For example, Apple outsources 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 total number of units produced. For example, if total fixed costs are $40,000, your variable costs are $20,000 and you produced 120,000 units. The total production costs are the $40,000 fixed costs added to the $20,000 variable costs for a total of $60,000. Divide 30,000 units by $60,000 to get $2 per unit production costs.

Breakeven Analysis

The calculated the unit cost of production is the breakeven point, the minimum price a unit must be sold to make a profit. For example, if a company produces 1,000 units that cost $4 per unit and are sold for $5 per unit. The profit is $5 minus $4, or $1 a unit. If a unit is sold at $3 per unit, there will be a loss because $3 minus $4 (cost) is a loss of $1 per unit.

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