Cost Per Unit: Importance, Formula, and Example
Cost per unit can have a major financial impact on businesses of all sizes. Learn how to calculate it and read about tips to reduce it here!
Reduce your cost per unit and increase operational efficiency by optimizing your delivery process with Circuit for Teams.
In any organization, understanding and monitoring key financial metrics that drive profitability is crucial for steering your business toward success.
One such metric is cost per unit, or the total cost of producing a product or service.
Learning how to cut costs is important if you want your business to thrive. This lets you reduce overhead expenses, streamline operations, and increase profits.
In this guide, we’ll explore the importance of understanding the cost per unit, discuss the formula to calculate it, and give a few tips and strategies to reduce this cost.
- The cost per unit is the total cost to produce, store, fulfill, and deliver a single unit of a product or service.
- Calculating the cost per unit can help your business better understand expenses and profitability.
- The unit cost formula is: (Total Fixed Costs + Total Variable Costs) / Total Number of Units Produced.
- Your business can reduce the cost per unit by negotiating better prices for raw materials, streamlining production and delivery processes, and reducing waste.
What does cost per unit mean?
The term "cost per unit" refers to the total amount of combined expenses (including both variable and fixed costs) needed to manufacture, store, fulfill, and deliver a single unit of a product or service to a consumer.
Let’s imagine you're a baker running your own cookie business.
You must factor in all of the ingredients, equipment, utensils, and other items used to make each batch of delicious cookies.
These costs help determine the cost per unit, which is how much each cookie costs to make.
The cost per unit formula
To determine the cost per unit, add the fixed and variable costs associated with producing a product or service and divide the total by the number of units produced within a specific time frame. Fairly easy, right?
The following equation represents the formula for calculating the cost per unit:
Cost Per Unit = (Total Fixed Cost + Total Variable Cost) / Number of Units Produced
It’s important to have a good grasp of your fixed and variable costs when trying to figure out how much it costs to make something or offer a service.
Variable expenses change in proportion to the level of production or sales. Think raw materials, shipping costs, commissions, and other fluctuating expenses.
Fixed costs, on the other hand, remain constant regardless of unit volume or sales. These costs may include property taxes, insurance premiums, asset depreciation, salaries, and other expenses that do not vary.
Example cost per unit calculation
Let's say a company produces 400 units of a product in one month.
The monthly fixed costs are $6,500, including rent, salaries, and insurance premiums.
The variable costs for the same month are $2,000, including raw materials and shipping expenses.
Use the following formula to calculate the unit cost:
Cost Per Unit = (Total Fixed Cost + Total Variable Cost) / Number of Units Produced
Plugging in the numbers, we have:
Cost per unit = ($6,500 + $2,000) / 400
Simplifying the equation, we get:
Cost per unit = $8,500 / 400
Cost per unit = $21.25
You can see this company’s cost per unit is $21.25. This means the company must price each unit at more than $21.25 to cover costs and make a profit.
Cost per unit vs. price per unit
The cost per unit refers to the expenses incurred by a company in producing a single unit of product, while the price per unit is the amount a customer pays to purchase that product.
For example, making one of your scrumptious cookies may only cost you $1.
But you might charge your customers $2.50 per cookie, which is the price per unit. That’s a profit of $1.50 per cookie sale.
Factors like the cost of production, demand, competition, and marketing strategies all play a role in determining the price per unit.
Generally, the price is higher than the cost per unit so the company makes a profit.
If the total price falls below the cost of producing something, the company could lose money.
Why is cost per unit important?
Cost per unit is crucial for your business to determine the minimum price (also called the break-even point) to cover expenses and prevent losses.
Compare the cost per unit to the price per unit to determine your company’s gross profit margins and adjust the selling price accordingly.
If the cost per unit is too high, your business may need to raise the price or reduce expenses to maintain profitability.
In addition, accurate calculations can help you identify cost-reduction opportunities and improve efficiency for long-term success.
5 Tips to reduce cost per unit for sellers
Implementing strategies to reduce costs associated with producing a product is beneficial to increase profitability and efficiency and streamline business processes.
In the case of eCommerce businesses, reducing the cost per unit can be especially important since these companies often face stiff competition and tight margins.
The following tips outline some effective strategies that eCommerce businesses can implement to reduce their cost per unit.
Reduce logistics costs
By implementing strategies to optimize your business's logistics and supply chain processes, you can reduce the average cost of production.
Specifically, you can reduce costs associated with transportation, warehousing, and inventory management.
One way to reduce these costs is by using Circuit for Teams to optimize delivery routes.
Our tool lets you find the fastest route options to deliver your items quickly and avoid traffic or road closures.
This means less idling and less wasted gas, saving you money in the long run.
Plus, real-time route tracking allows you to monitor your delivery drivers’ progress, make route changes so they arrive on time, and reduce the costly risk of failed deliveries.
Your team may also consider implementing lean inventory management practices and utilizing efficient warehouse layouts to minimize storage costs.
When you use your warehouse space efficiently (like adding shelves, organizers, and wall storage), you can fit more items into less space.
This means you won't have to rent or build extra storage facilities, saving you money in the long run.
Another effective approach is investing in automation technology like automated warehouses and order fulfillment systems.
Automation can reduce direct labor costs by performing repetitive and labor-intensive tasks normally saved for human workers.
This frees up your staff to focus on higher-value tasks, increasing overall productivity and efficiency.
Lower your overhead costs
Overhead costs are indirect expenses incurred by a business to support its operations.
These costs include expenses like rent, payroll, legal fees, utility costs, and insurance.
You can reduce these costs by taking a comprehensive look at your business operations and identifying areas where you can make adjustments.
The following are some effective strategies to reduce overhead costs:
- Evaluate your insurance policies. Analyze your coverage to make sure you are not overpaying for protection.
- Outsource payroll processing or bookkeeping. This can be a cost-effective way to manage financial operations without hiring full-time employees.
- Reduce unnecessary office space. This can reduce expenses associated with rent, utilities, and maintenance.
Decrease material costs
Decreasing material costs can reduce the cost per unit by lowering expenses associated with raw materials, production, and inventory management.
One effective way to reduce material costs is by sourcing materials from cheaper suppliers. Consider comparing different options to find high-quality materials at a lower cost.
In addition, optimize your production processes by eliminating errors resulting in excess raw materials.
Prevent excess materials by tracking inventory to avoid overproduction. It’s also important to properly train your employees to reduce product defects, and only order the necessary direct materials for production.
To put this into perspective, a baker might closely monitor flour usage and only order the amount needed for the following week's production.
This can reduce carrying costs associated with excess inventory, such as storage, insurance, and handling costs.
Reduce returns and dead stock
Your business can increase profitability by implementing strategies to reduce customer returns and dead stock (that is, items that have not sold and are no longer in demand).
Reduce the return rate by making sure your product is high quality, meets customer needs, and is properly packaged and shipped to avoid damage during transit.
We have a tool that helps your drivers find specific packages in their trucks quickly, reducing the chances of damaging other packages while searching for the one they need.
And, of course, delivering packages in good condition is key to maintaining happy customers.
Additionally, giving clear and accurate product descriptions, images, and specifications can help manage customer expectations and reduce the likelihood of returns.
And by implementing effective customer management practices, you can make sure orders are fulfilled on time and customers are satisfied with their purchases.
To reduce dead stock, consider implementing effective inventory management strategies, such as forecasting demand, regularly reviewing and adjusting stock levels to avoid inventory shrinkage, and identifying slow-moving products.
Likewise, offering promotions, discounts, or bundles for slow-moving products can help clear out inventory and reduce dead stock.
Remove unprofitable products
Unprofitable products can accumulate unnecessary storage fees and tie up capital better used elsewhere in your business.
Take a look at these easy-to-follow steps to eliminate unprofitable products from your inventory:
- Identify unprofitable products. Find out which products are unprofitable by calculating their cost per unit and comparing it to the selling price. If the cost per unit is higher than the selling price, those products are costing you more money than they're worth.
- Use inventory management software to forecast demand. This can help you track inventory to monitor the cost of goods sold and make informed decisions about which products to discontinue.
- Liquidate excess inventory. Host clearance sales or promotions to sell off slow-moving products.
- Consider returning items to your supplier or wholesaler. You may be able to get a partial refund, credit, or exchange for unprofitable products. Thankfully, you can use Circuit for Teams to identify free time windows in your delivery schedule and plan efficient routes to integrate product returns into your regular route plan.
Optimize your in-house shipping process with Circuit for Teams
Whether you're a small business or a larger corporation, Circuit for Teams can help you reduce fuel costs and streamline your delivery processes.
Our innovative tool allows you to easily prioritize delivery stops and manage multiple routes, saving you valuable time and fuel costs.
Not to mention, Circuit for Teams lets you monitor your team's routes, make last-minute live changes, and get real-time delivery status updates.
Plus, our user-friendly interface and intuitive features make it easy for anyone on your team to use, so you can hit the ground running from day one.