Get Even More Visitors To Your Blog, Upgrade To A Business Listing >>

Average Total Cost Formula

Average Total Cost Formula

Formula of Average Total Cost (Table of Contents)

  • What is Average Total Cost Formula?
  • Examples of Average Total Cost
  • Average Total Cost Formula Calculator

What is Average Total Cost Formula?

The formula of Average total cost is very simple and it is calculated by dividing the total cost of production by the number of goods produced.

The average total cost formula is represented as –

Average Total Cost = Total Cost of Production / Quantity of Units Produced

However, the total cost is comprised of fixed cost and Variable cost of production. Mathematically,

Total Cost of Production = Total Fixed Cost + Total Variable Cost

Conversely, the average total cost equation can also be calculated by adding up average fixed cost and average variable cost. This average total cost equation is represented as follows-

Average Total Cost = Average Fixed Cost + Average Variable Cost

where,

  • Average fixed cost = Total fixed cost/ Quantity of units produced
  • Average variable cost = Total variable cost/ Quantity of units produced

Explanation of the Average Total Cost Formula

The equation of average total cost can be determined by using the following five steps:

Step 1: Firstly, the fixed cost of production is collected from the profit and loss account. Few examples of the fixed cost of production are depreciation cost, rent expense, selling expense etc.

Step 2: Next, the variable cost of production is also collected from the profit and loss account. Few examples of the variable cost of production are raw material cost, labor cost etc.

Step 3: Next, the total cost of production is calculated by summing up the total fixed cost and total variable cost.

Total Cost of Production = Total Fixed Cost + Total Variable Cost

Step 4: Now, the quantity of units that has been produced has to be determined.

Step 5: Finally, the average total cost of production is calculated by dividing the total cost of production calculated in step 3 by the number of units produced determined in step 4.

Average Total Cost = Total Cost of Production / Quantity of Units Produced

Examples of Average Total Cost Formula

Let’s see some simple to advanced example to understand the calculation of Average Total Cost Equation Better.

Average Total Cost Formula – Example #1

Let us consider an example where the total fixed cost of production of a company stood at $1,000 and the variable cost of production is $4 per unit. Now, let us do the calculation of the average total cost when the quantity of production is:

  • 1,000 units
  • 1,500 units
  • 3,000 units

In below template, we have done the calculation of  Total Cost of Production using the given data.

  • So the total cost of production at 1,000 units will be calculated as:

Average Total Cost Formula

So from the above calculation, the total Cost of Production for 1000 units will be:

= $1,000 + $4 * 1,000

Average Total Cost Formula Example 1-1

Now, the Average total cost of production at 1,000 units will be calculated as:

= $5,000 / 1,000

Average Total Cost Formula Example 1-2

  • Total Cost of Production for 1500 units

= $1,000 + $4 * 1,500

Average Total Cost Formula Example 1-3

So, Average Total Cost for 15000 units will be –

$7,000 / 1,500

Average Total Cost Formula Example 1-4

  • Total Cost of Production for 3000 units

= $1,000 + $4 * 3,000

Average Total Cost Formula Example 1-5

So, Average Total Cost for 3000 units will be –

= $13,000 / 3,000

Average Total Cost Formula Example 1-6

In this case, it can be seen that the average total cost decreases with the increase in the production quantity which is the major inference from the above cost analysis.

Average Total Cost Formula – Example #2

Let us consider another example where the total fixed cost of production of a company stood at $1,500 while the variable cost of production per unit varies with production quantity. Now, let us calculate the average total cost when:

  • Variable cost is $5.00 per unit from 0-500 units
  • Variable cost is $7.50 per unit from 501-1,000 units
  • Variable cost is $9.00 per unit from 1,001-1,500 units

Therefore,

  • Total cost of production at 500 units = Total fixed cost + Total variable cost

= $1,500 + $5 * 500

Average Total Cost Formula Example 2

Average total cost of production at 500 units = $4,000 / 500

Average Total Cost Formula Example 2-3

Again,

  • Total cost of production at 1,000 units = Total fixed cost + Total variable cost

= $1,500 + $5 * 500 + $7.5 * 500

Average Total Cost Formula Example 2-1

Average total cost of production at 1,000 units = $7,750 / 1,000

Average Total Cost Formula Example 2-2

Again,

  • Total cost of production at 1,500 units = Total fixed cost + Total variable cost

= $1,500 + $5 * 500 + $7.5 * 500 + $9 * 500

Average Total Cost Formula Example 2-4

Average total cost of production at 1,500 units = $12,250 / 1,500

Average Total Cost Formula Example 2-5

In this case, it can be seen that the average total cost initially decreases with the increase in the production quantity till 1,000 units but then the trend reverses beyond that production level due to increase in the average variable cost. The detailed excel calculation is presented in tabular format in the later section.

Average Total Cost Formula Calculator

You can use the following  Average Total Cost Formula Calculator.

Total Cost of Production
Quantity of Units Produced
Average Total Cost Formula =
 

Average Total Cost Formula =
Total Cost of Production
=
Quantity of Units Produced
0
= 0
0

Relevance and Use of Average Total Cost Formula

It is very important to understand the concept of average total cost formula since it helps a production manager to figure out till what level the production can be increased profitably. Usually, the total fixed cost doesn’t change and as such, the change in average total cost is primarily driven by the change in average variable cost. In cases where the average total cost breaches the permissible limit then the production manager should either halt the incremental production or try to negotiate the variable cost. In this way, the formula of the average total cost is useful for a business.

Example of Average Total Cost Formula (with Excel template)

The following table gives a detailed calculation of the case discussed in example 2 and shows how average total cost varies with the change in quantity produced. Here, the average total cost reverses trend after a certain point which indicates that at that level of production the cost of production starts to increase after the initial phase of moderation.

In the below given excel template, we have used the Average Total Cost Formula calculation to find the Average Total Cost for certain units produced.

avg formula eg 3.1png.

So the Average Total Cost Calculation will be:-

avg formula eg 3.2png.

The below-given graph shows the Average Total Cost of Company.

avg graph

You can download this Average Total Cost Formula Excel template here – Average Total Cost Formula Excel Template

Recommended Articles:

This has been a guide to Average Total Cost Formula. Here we discuss how to calculate Average Total Cost along with practical examples and downloadable excel templates. You can learn more about accounting from the following articles –

  • Break-Even Point Formula
  • Explain Direct Costs
  • What is Variable Costing Income Statement
  • Calculate Unit Contribution Margin

The post Average Total Cost Formula appeared first on Learn Investment Banking: Financial Modeling Training Courses Online.



This post first appeared on Free Investment Banking Tutorials |WallStreetMojo, please read the originial post: here

Share the post

Average Total Cost Formula

×

Subscribe to Free Investment Banking Tutorials |wallstreetmojo

Get updates delivered right to your inbox!

Thank you for your subscription

×