Guide to Marginal Cost
Marginal cost refers to the change in the sum of costs which arise when the number of units produced increase by one. In simple words, it is the cost incurred to produce one more unit of that product. By calculating the marginal costs, you will be able to know whether it is reasonable to manufacture that additional unit. Thus, apart from hiring a bookkeeping firm in Singapore to help you with financial accounting, do not forget to pay attention to your cost accounting too as this is crucial for the long-term profitability of your business.
There are two elements in the cost of production, which are the fixed costs as well as the variable costs. The former is the sum of expenses (Also see Capitalizing versus Expending costs) which will not be influenced by the productivity of a business and will not change as time passes. For instance, rentals, insurance, salaries and property taxes are some of the costs that will not change regardless of the number of products manufactured.
On the other hand, the latter, which is the variable cost, is the sum of expense that will change according to the fluctuations in the output, and it will change throughout an accounting period. Expenses that fall under the category of variable costs include the cost incurred on the purchase of raw materials, direct labour, sales commissions and others.
The calculation of marginal costs involves a few steps. Firstly, business owners need to calculate the change in the total cost by subtracting the old cost from the new cost. The next step is to subtract the old quantity from the new quantity to arrive at the change in the number of products produced. Lastly, to calculate the marginal cost, business owners need to divide the change in the total cost by the change in the number of items.
As an example, Sarah is a florist who makes flower bouquets for her customers. Let’s say in January, Sarah had made 100 bouquets, and Sarah had spent RM3000 to make all of them. In February, the sales had increased to 150 bouquets due to Valentine’s Day, and the cost of production was RM4000. Hence, to calculate the marginal cost, Sarah should first calculate the change in the total costs and the change in the number of the bouquets produced, which was RM1000 (RM4000 – RM3000) and 50 (150 – 100) respectively. Thus, the marginal (Also see An Overview of Gross Margin) cost is RM20 (RM1000/50), that is, Sarah needs to spend an extra RM20 for each additional bouquet of flowers.
Another term that people always confused with the marginal cost is the marginal benefits. Marginal benefit refers to the maximum amount of money that the customer is willing to spend on an extra product or service. Marginal (Also see What Are Margin and Markup?) cost, on the other hand, is the difference in the total costs (Also see What is Included in Your Inventory Cost?) when the company produces an extra product or service.