The formula
cost per unit = fixed costs ÷ units + variable cost
What it means
The cost of a unit has two parts that behave in opposite ways. The variable cost — materials, direct labour — is the same whether you make ten or ten thousand. Fixed costs do not move with production, so the more units you make, the smaller the share each one carries. That is why cost per unit is not a fixed property of the product: it depends on the volume.
How to work it out by hand
- Add up the fixed costs for the period: rent, salaries, machinery
- Divide that by the units produced
- Add the variable cost of each unit
- Repeat at another volume to see how far it falls
What is worth knowing
The fall in cost per unit as volume rises is a hyperbola, not a straight line: the first increases in production cut the cost a great deal and past a certain point they barely move it, because the variable cost is the floor it never goes below. With 10,000 of fixed costs and 4 of variable, going from 100 to 1,000 units takes the cost from 104 to 14; going from 10,000 to 100,000 only takes it from 5 to 4.1. That is where pricing off the unit cost of a volume you have not yet sold goes wrong: produce half of what you planned and the real cost jumps and the margin disappears. And watch the break-even point: it does not come from dividing the fixed costs by the price, but by the contribution, which is the price minus the variable cost.