Fixed costs are the costs associated with the production of a commodity that do not undergo changes, regardless of the number of commodity units produced. For example, if your company manufactures curtains, the list of fixed costs will include items such as premises rent, sewing machines, storage containers, overhead lighting fixtures, and chairs. The average fixed cost is the amount of fixed cost per unit of product. As production grows, the fixed cost goes down and it makes more sense, economically, to produce as many units as possible only if the fixed costs always remain the same. However, if the price of the product is not higher than the average fixed cost, it may not be cheaper to continue production. For this reason it is important to calculate the average fixed cost of a product and compare it with its price, to establish whether it is convenient, from an economic point of view, to continue producing it. There are two methods of calculating the average fixed cost. Follow the instructions to learn how to calculate it.
Steps
Method 1 of 2: Division
Step 1. Make the total sum of fixed costs
Step 2. Determine the amount of units produced
Step 3. Divide the total fixed costs by the quantity of units produced to get the average fixed cost
For example, if the fixed cost amount is 10,000 euros and 1000 units are produced, then the average fixed cost will be 10 euros.
Method 2 of 2: Subtraction
Step 1. Calculate the total cost
This is the total amount of money needed to produce a single unit of product, equal to the total fixed cost plus the total variable cost. In this calculation every element of production must be taken into account: labor, commissions, electricity, marketing, administrative costs, office supplies, shipping costs, materials, interest and any other costs that relate to the specific product.
Step 2. Calculate the total average cost
The total average cost equals the total cost divided by the number of units produced. If the total cost is 1000 euros and the units produced are 200, then the average total cost will be 5 euros.
Step 3. Determine the amount of the total variable cost
Variable costs change according to the quantity of units produced, directly proportional to the increase and decrease of production. The two main variable costs are labor and materials.
Step 4. Calculate the average variable cost by dividing the total variable costs by the number of units produced
For example, if the total variable cost is 400 euros and the units produced are 200, the average variable cost will be 2 euros.
Step 5. To find the average fixed cost, subtract the average variable cost from the average total cost
In our example, subtracting the average variable cost of 2 euros from the average total cost of 5 euros, we find the average fixed cost, which is equivalent to 3 euros.
Advice
- The average fixed cost can never be zero or negative, because the amount of fixed costs is always a positive number.
- When you add up all of the fixed costs to determine the average fixed cost, you include the cost of renting the premises, including insurance and real estate taxes.
- To lower the average fixed cost it is necessary to reduce the fixed costs.
