What is the total cost?
He Total cost It is an economic measure that adds fixed costs, which do not depend on what is produced, and variable costs, which do increase or decrease depending on production.
Unlike cost accounting, full cost in economics includes the full opportunity cost of each factor of production as part of its fixed or variable costs.
Total cost is the total economic cost of production. It is made up of a variable cost, which varies according to the quantity of a good produced, including inputs such as labor and raw materials.
In addition, it is made up of a fixed cost, which is an independent value of the quantity of a good produced. Includes expenses that cannot be changed in the short term, such as buildings, equipment, and machinery.
The rate at which total cost changes as the quantity produced changes is called marginal cost. This is also known as the marginal unit variable cost.
Importance
This is a fundamental concept for business owners and executives, because it allows you to track the combined costs of operations.
The meaning of this term varies slightly depending on the context. For example, when used to define production costs, it measures the total fixed, variable, and overhead costs associated with the production of a good.
It allows people to make pricing and revenue decisions based on whether total costs are increasing or decreasing.
Additionally, interested individuals can dig deeper into total cost figures by separating them into fixed costs and variable costs, and adjust operations accordingly to reduce overall production costs. Management also uses this idea when considering capital expenditures.
In marketing, it is necessary to know how total costs are divided between variable and fixed. This distinction is crucial for forecasting the revenue generated by various changes in unit sales and thus the financial impact of proposed marketing campaigns.
Function of the total cost of production
The cost function is the mathematical relationship between the cost of a product and its various determinants. In this function, the unit cost or total cost is the dependent variable.
Variable and fixed factors
It helps to determine more precisely what the fixed and variable costs would be during production. For example, a company employs more workers or buys more raw materials to increase production. These are the variable factors. Factors such as infrastructure, production equipment, etc., are not so easy to adjust. The company usually requires more time to make changes to them. These factors are the fixed factors.
Based on an understanding of variable and fixed factors, short-run and long-run periods can be looked at to better understand short-run total costs.
Short and long term periods
It helps to define short-term production deadlines, and consequently increase or decrease production based on needs, by making changes only in variable factors (labor, raw material, etc.).
The long term is a period of time in which the company must make changes in all factors in order to obtain the desired result. It can be said that, in the long run, all factors become variable.
Fixed and Variable Factor Costs
It is important to note that these factors, fixed or variable, generate costs. It can be seen below:
Fixed costs
Fixed costs are those that do not vary with production and typically include rent, insurance, depreciation, and setup costs. They are also called overhead.
In Figure 1 it can be seen that fixed costs are independent of production. That is, they do not change with any modification in the production output.
The firm incurs these costs regardless of the size of the output. The company must bear these costs, even if it closes its operations in the short term.
Fixed costs typically include charges such as rent, insurance premium, maintenance costs, taxes, etc.
Variable costs
Variable costs vary with production and are also called direct costs. Examples of typical variable costs include fuel, raw materials, and some labor costs.
In Fig. 2 it can be seen that variable costs change with changes in production output. Variable costs include payments such as salaries, raw material expenses, energy consumption, etc.
If a company closes its operation in the short term, then it will not use the variable factors of production. Therefore, you will not incur variable costs.
Total cost curve
The total cost (TC) of a business is the sum of the total variable costs (TCV) and the total fixed costs (CFT). Therefore, we have: CT = CFT + CVT.
The following graph represents the total fixed cost, total variable cost, and total cost curves:
As can be seen, the CFT curve starts from a point on the Y axis, being parallel to the X axis. This implies that even if output is zero, the firm will incur a fixed cost.
On the other hand, the CVT curve rises upwards. This implies that the CVT increases as production output increases.
This curve starts from the origin, which shows that there are no variable costs when production output is zero.
Finally, it is observed that the total cost curve (TC) is obtained by adding the CFT with the CVT.
How is it calculated?
Add up the fixed costs of the business
In the business environment, fixed costs are often called overhead costs. These represent the amount of money that the company needs to spend to continue operating.
More accurately, it could be said that fixed costs are the costs that neither decrease nor increase as the company produces fewer or more services and goods.
Fixed costs for a business are similar, though not exactly the same, as the costs that are placed on a personal budget.
Among the fixed costs of a company are: rent, public services, building leases, equipment, machinery, insurance premiums and labor that is not involved in the production of services and goods.
For example, suppose you own a plant that makes tennis balls. The fixed monthly costs are as follows:
Building lease = $4,000.
Loan payments = $3,000.
Insurance premiums = $1,500.
Equipment = $2,500.
In addition, $7,000 per month is paid to employees who do not directly affect the manufacture of tennis balls: security guards, administrative assistants, etc. By adding all these values, you get a value for fixed costs of: $4,000+ $3,000+ $1,500+ $2,500+ $7,000 = $18,000.
Calculate variable costs
Variable costs in businesses are a bit different than personal budgets. The variable costs of a company are the expenses directly affected by the quantity of services or goods produced.
That is, the more a company grows in relation to the services provided, goods produced, etc., the higher its variable costs will be.
Variable costs for a business include raw materials, personnel involved in the production process, shipping costs, etc.
Additionally, services can also be a variable expense, if they oscillate with the company’s production.
examples
For example, suppose a robotic car factory has a large consumption of electricity. The electricity consumption you need will increase as you make more cars. That is why the different public services can be classified as variable cost.
Continuing with the example of the tennis ball manufacturing plant, it can be said that variable costs include:
Rubber = $1,000.
Shipping = $2,000.
Factory worker wages = $11,000.
The factory also consumes large quantities of natural gas for the process that vulcanizes the rubber. This cost increases as production increases. The utility bill for this month was $3,000.
Adding all these expenses, you get a total variable cost of: $1,000+ $2,000+ $11,000+ $3,000 = $17,000.
Determine the total cost
The formula for calculating the total costs of a company is quite simple:
Total cost = fixed costs + variable costs.
Taking the example, given that the fixed costs are $18,000 and the variable costs are $17,000, the total monthly cost for the plant is $35,000.
Business costs in financial statements
Most of the variable and fixed costs of companies can be found in the financial statements.
Specifically, the profit and loss statement must contain all variable costs related to the production of the company’s services and goods, together with important fixed costs, such as administrative staff salaries, rent, etc.
The profit and loss statement is a standard financial instrument. All companies that have some form of accounting exercise should have one.
Also, to see how much money the business needs for future payments, another financial statement, called a balance sheet, may need to be looked at.
The balance sheet contains, in addition to other important figures, a company’s liabilities, which is the amount of money owed to other entities.
This can help establish the financial health of the company. If you are barely making enough money to cover the full cost and have significant liabilities, the company may be in a poor position.
Total Cost Formula
The total cost formula is used to derive the combined variable and fixed costs of a batch of goods or services.
The formula is the average fixed cost per unit plus the average variable cost per unit, multiplied by the number of units. The calculation is:
Total cost = (average fixed cost + average variable cost) x number of units.
For example, a company is incurring $10,000 of fixed costs to produce 1,000 units, giving an average fixed cost per unit of $10, and its variable cost per unit is $3. At the production level of 1,000 units, the total cost of production is:
($10 Average Fixed Cost + $3 Average Variable Cost) x 1,000 Units = $13,000 Total Cost.
Problems with the formula
There are several problems with the total cost formula. To correct these problems, it is necessary to recalculate the total cost each time the production volume changes by a quantity of material.
Limited range for average fixed cost
The definition of fixed cost is that it is a cost that does not vary with production volume, so the average fixed cost part of the formula should only be applied within a very narrow production volume range.
In reality, the same fixed cost is likely to apply across a wide range of production volumes, so the average fixed cost figure could vary wildly.
