Fixed costs are costs associated with producing a product and the amount does not change, no matter how many units are produced. For example, if the business manufactures curtains, the product's fixed costs consist of building rent, sewing machines, storage containers, overhead lighting fixtures, and sewing chairs. The average fixed cost (average fixed cost or AFC) is the total fixed cost per unit of product produced. There are several methods for calculating AFC, depending on the type of information being worked on. Follow the steps below to calculate and use average fixed costs.
Step
Method 1 of 3: Using the Division Method
Step 1. Choose the range of the period to be measured
You should choose a clear range of calculation periods. Thus costs can be aligned with production and fixed costs can be calculated correctly. In general, it is easier to use a month or another round number so that fixed costs can be determined easily. You can also approach from the other end and use a certain number of units of production time.
For example, you can calculate production of 10,000 units every two months and use that time constraint to calculate the business's fixed costs
Step 2. Combine the total fixed costs
The amount of fixed costs often does not depend on the units of production produced. These costs include the rent of the building used to produce or sell the product, maintenance costs for manufacturing equipment, Land and Building Tax, and insurance. Fixed costs also include payroll costs for employees who are not directly involved in the manufacturing process. Add them all together to determine the total fixed cost value.
- Using the previous example, the business generated 10,000 units in two months. Let's say a business pays IDR 4,000,000 per month for rent, IDR 800,000 per month for Land and Building Tax, IDR 200,000 for insurance, IDR 5,000,000 for administrative salaries, and IDR 1,000,000 for depreciation expense on production machines. The total fixed fee is IDR 11,000,000 per month. Since the calculation period spans two months, multiply by two to get a total fixed cost of $22,000.
- For more information, see how to calculate fixed costs (warning, english article).
- Keep in mind that these costs do not include variable costs, or costs that are based on the number of units produced. Variable costs can be in the form of production raw materials, utility costs, manufacturing labor costs, and packaging costs.
Step 3. Determine the quantity of units produced
Just use the number of units produced in the period being measured. Make sure the measurement period range is the same as the period used to calculate total fixed costs.
In the previous example, the number of units produced in the measurement period (two months) was 10,000 units
Step 4. Divide the total fixed cost figure by the number of units produced
The result is the average fixed cost of the business. To complete our example, divide the total fixed costs of $22,000 for two months by 10,000 units produced in that month. You will earn IDR 2,200 per unit.
Method 2 of 3: Using the Subtraction Method
Step 1. Calculate the total cost
The total cost in question is the total amount to produce a product, the formula is the total fixed cost plus the total variable cost. All elements of production must be included in the total cost, including labor, utilities, marketing, administrative, office supplies, handling and shipping costs, raw materials, interest and other costs that are retained on a specific product.
Step 2. Find the average total cost (ATC)
ATC is the total cost divided by the number of units produced.
Continuing the previous example, if the total production cost is $35,000 for two months for 10,000 units of product, the ATC value is $3,500 per unit
Step 3. Determine the total variable cost amount
The amount of variable costs depends on the number of units of production produced. Its value goes up when production is high, and falls when production is low. For example, the two most dominant variable costs are the cost of raw materials and production labor. Variable costs also include the costs of utilities directly involved in production, such as electricity and gasoline used during the manufacturing process.
- Continuing from the previous example, let's say the total variable costs are $2,000,000 for raw materials, $3,000,000 for utilities ($1,500,000 per month), and $10,000,000 for salaries (Rp5,000,000 per month). Add these numbers together to get a total variable cost of $15,000 for two months.
- For more information, see how to calculate variable costs (warning, english article).
Step 4. Calculate the average variable cost (AVC) by dividing the total variable cost by the number of units produced
Therefore, divide the total variable cost of Rp. 15,000,000 by 10,000 units and obtain an AVC of Rp. 1,500 per unit.
Step 5. Calculate the average fixed cost
Subtract the average variable cost from the average total cost. The result is the average fixed cost of the business. In the example above, the average variable cost of IDR 1,500 per unit needs to be subtracted from the average total cost of IDR 3,500 per unit. The result is an average fixed cost of Rp. 2,000 per unit. Remember, this value is the same as the number we calculated in method 1.
Method 3 of 3: Analyzing Production Performance Using Average Fixed Costs
Step 1. Use AFC to check product profitability
AFC can help you understand the potential profitability of a product. Before starting a project, do a break-even analysis to understand how AFC, AVC and price affect time to profitability. In general, the most important thing is that the selling price must be above the AVC of the product. The excess is then used to cover fixed costs
AFC goes up when production increases so people often misunderstand that producing as much as possible (while keeping total fixed costs) is the way to make a profit
Step 2. Perform load analysis using AFC
You can also use the AFC to determine the load to be reduced. Reducing expenses may be necessary due to market conditions or simply increasing profits. If the total costs are mostly fixed costs, you should look for fixed costs that can be deducted. For example, reduce electricity use with more energy efficient lamps or fixtures. The AFC can help you see the impact these changes have on your business's profit per product.
Reducing fixed costs will give the business more operating leverage (bigger profits as production increases). In addition, the number of sales needed to reach the break even point is also reduced
Step 3. Use the AFC to find out the economies of scale of the business
Economies of scale are the advantages that arise from large quantities of production. In essence, a business can lower its fixed costs per unit and increase its profit margin by increasing production. Find AFC values at different levels of production to see how much business profitability increases by increasing production. You can compare this to the price to reach this level of production (perhaps as additional manufacturing space or purchasing machinery) to determine whether expansion will be profitable for the business or not.
