Fixed cost per unit is calculated by dividing the total fixed costs by the number of units produced.
Fixed Cost per Unit Formula Example
A business has 86 per unit in variable costs and 120,000 per year in fixed costs. The business operates at a markup of 40%. What is the selling price when demand and production is 1,000 units and 3,000 units.
Example 1: Production Level – 1,000 units
Fixed Cost (FC)
At a production level of 1,000 units the calculation of the fixed cost per unit is as follows.
Fixed costs = 120,000 Units = 1,000 Fixed cost per unit = Fixed costs / Units Fixed cost per unit = 120,000 / 1,000 = 120 per unit
In this case at a production level of 1,000 units the FC per unit is 120.
Total Unit Cost
The total unit cost is the sum of the fixed cost and variable cost per unit. At this level of activity the total unit cost is calculated as follows.
Unit cost = Variable cost + Fixed cost Unit cost = 86 + 120 = 206
The total unit cost of the product at this level of production is 206.
Using this unit cost the business can now calculate the selling price of the product needed to achieve a given gross margin.
Selling price = Cost x (1 + Markup) Selling price = 206 x (1 + 40%) = 288.40
As can be seen with this fixed and variable cost structure the business must sell the product at a price of 288.40 to achieve a 40% gross margin.
Example 2: Production Level – 3,000 units
The next example is used to demonstrate how increasing production changes the fixed cost per unit. In this example production is set at 3,000 units.
Fixed Cost (FC)
As before the fixed cost per unit is calculated as follows.
Fixed costs = 120,000 Units = 3,000 Fixed cost per unit = Fixed costs / Units Fixed cost per unit = 120,000 / 3,000 = 40 per unit
As can be seen increasing the production from 1,000 to 3,000 units has resulted in the unit FC falling from 120 to 40 per unit.
Total Unit Cost
The calculation of the total unit cost at this level of activity is as follows.
Unit cost = Variable cost + Fixed cost Unit cost = 86 + 40 = 126
In similar fashion the calculation of the selling price is as follows.
Selling price = Cost x (1 + Markup) Selling price = 126 x (1 + 40%) = 176.40
As shown above the required selling price to achieve a 40% gross margin is now 176.40. It is important to realize that by increasing production from 1,000 to 3,000 units the selling price to achieve a 40% gross margin has fallen from 288.40 to 176.40
This example demonstrates the importance of fixed costs and the economies of scale achieved with higher levels of production
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.