As a small business owner, you may have come across the concept of a total cost formula. To calculate total costs can be crucial in understanding your business's profitability, which will help avoid financial difficulties and improve your business planning. This is why we've compiled this short guide to what the total cost formula is, the total variable cost vs total fixed cost, examples, and considerations.
What is the total cost?
Cost itself can be understood as the value of money required to produce a product. The total cost refers to the total e.g. production costs, including both fixed and variable costs. This is the economic cost of production. As cost is one of the most significant factors determining whether your business is successful or not, understanding the different types of costs that occur in your business and the impact they have on profitability is key when maintaining finances. That is why small business owners must understand what the total cost is and how to calculate it.
Total Variable Cost vs Total Fixed Cost
- Variable costs are costs that change, depending on different factors. This could, for example, be how many goods you sell or how much of a service you use. It is not dissimilar to a household gas bill going up or down, depending on how much the heating is used.
- Fixed costs, on the other hand, are costs that do not change from e.g., month to month, depending on factors such as the number of products sold. Fixed costs, on the contrary, are stable. This could, for example, include the rent for your company property or your staff salaries.
What is the total cost formula?
First, you have to identify the total number of units produced (i.e. the number of product units manufactured throughout a specific time period).
- The formula for the total cost is as follows: Total Cost of Production = (Total Fixed Cost + Total Variable Cost) x Number of Units.
It is important to consider how the formula may have to be adapted to suit your business.
Example of Total Cost Formula
Company A produces calculators. The total fixed cost per calculator produced is GPB 25. The variable cost, depending on units sold and cost of the parts required is c. GPB 1,5. Company A sells 14,000 calculators per month.
Therefore, the total cost gets calculated as follows:
Considerations for Total Cost Formula
Of course, there are several advantages to using the total cost formula. Primarily, it is a clear and easy-to-use metric to assess the profitability of your company's operations. You can keep an eye on the total cost over time to see if e.g. your pricing strategy needs reviewing. It can also be useful to compare your total cost with competitors' consumer prices.
When deciding on suppliers it can be very useful to have an understanding of much budget you have, depending on the cost of production.
However, there are some considerations with using the total cost formula. If your business is producing a high number of different products it can be difficult to allocate costs to arrive at the total. Also, the more a variable cost changes, the more complex it can be to calculate the total cost and the more prone to mistakes the calculations are.
What is more, making pricing strategies dependent on the total cost of production can be a risk as prices e.g., raw materials can change in unpredictable ways.
- What is a good total cost?
The total cost refers to the total e.g., production costs, including both fixed and variable costs. What a good total cost depends on the price point of your product - the balance of cost and revenue ultimately defines the profitability of your business operations.
- Examples of Total Cost Formula in business
Company B repairs laptops. They rent a factory for GPB 150,000 per month and pay a total of GPB 350,000 in staff salaries per month. These are their fixed costs. The cost of manufacturing depends on e.g., the number of laptops repaired and the cost of supplied products. These are their variable costs.