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Marginal Cost: Definition and Calculation

Companies must know how much it costs to spend in a particular production cycle, and it is vital for price and production planning. A decrease or increase in the total cost paid due to the addition or reduction of one additional product unit. The accounting system can assist in calculating marginal costs, especially monitoring the factors that influence them.

The importance of marginal cost

The goal of marginal cost analysis is to determine at which point the firm can achieve economies of scale. It means cost advantage that accrues when production becomes efficient. This aims to optimize the overall operational system. To calculate this, determine your fixed and variable costs.

Type of component

Information related to the types of costs associated with production such as fixed costs and variable costs are needed. Fixed costs do not change with increasing production, while variable costs are in the opposite condition. Variable costs depend on yield and are a constant amount per unit produce. As production and output volumes increase, variable costs will also increase. Examples of variable costs are sales commissions as well as direct labour and raw material costs.

Meanwhile, fixed costs are costs that are constant regardless of production output and do not depend on output. Examples are rental costs, employee salaries, insurance, and office supplies.

Calculate marginal cost

Formula:

Marginal Cost = (Change in cost) / (Change in quantity)

Change of fees

Cost changes are the increase or decrease in production costs at each level of production and during any given period of time, especially when the need arises to produce more or less product.

If the creation of additional units requires the recruitment of one or two additional workers and increases the cost of purchasing raw materials, then it is certain that there will be a change in overall production costs.

To determine the cost changes, subtract the production costs that occur during the first production run from the production costs in subsequent waves when the volume of output increases.

Change in quantity

In various levels of production, it is commonplace when the number of goods produced increases or decreases. To determine the change in quantity, do the calculation between the number of goods made in the first production process subtracted from the volume of output made in the next production process.

Study case

For example, suppose a company produces 1000 watches in one production activity. Businesses want to analyze the costs of operating the next wave of production to determine marginal costs. This item is subject to a price of IDR 500,000 per unit. If a business is considering producing another 1,000 units, they need to know the projections in advance.

The company later found that it cost IDR 400,000 to produce another hour. If the business has a lower marginal rate, then higher profits will be obtained. When the watch is marketed at a price of IDR 750,000 per piece, they will get IDR 250,000 profit for each unit in the first production. And they will make a profit of IDR 350,000 from an additional watch.

Conclusion

Companies must always remember that marginal revenue and marginal cost must be the same so that the profit earned can be maximized. When it has been calculated using the formula above, the company can know how much output can produce the highest profit. You may need to go through trial and error before finding optimal profit margins and maintaining sales and increased revenue.

Also read:

7 Key Benefits of Using an Accounting System in Your Company

4 Key Benefits of Using an Accounting App

Interest in getting savvy tips for improving your business efficiency?

Anatha Ginting
A full-time Content Writer at HashMicro. Strive to develop my writing skill and knowledge in terms of business, technology, and other relevant issues.

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