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Marginal Cost: Meaning, Formula, and Examples
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Marginal Cost calculates the production cost for each additional product or service unit.
Marginal Cost is short when the company has to pay the cost of producing a unit from its capital.
Marginal Cost is zero when the cost of producing a unit is zero.
The Marginal Cost may vary over time, so it is more appropriate for short-term than long-term planning.
If it costs Rs. 1,000 to make 100 bracelets and Rs. 80 to make one more, then the Marginal Cost to produce one additional bracelet is Rs. 80.
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Business owners must understand their company's cost structure to keep up with the competition. Marginal Cost lets managers make better product mix, pricing, and profitability decisions. Calculate the Marginal Costing by subtracting variable costing from fixed costing. Learning how to calculate Marginal Cost explains the impact of changing production volumes on a business’s bottom line. Accordingly, business owners can optimise their operations to maximise profits.
Read on to understand Marginal Cost meaning, definition, and examples.
What is Marginal Cost?
As the Marginal Cost definition indicates, companies use a cost accounting technique to determine their production cost for each additional product or service unit. The costs are calculated based on variable costs like raw materials and direct labour. According to the Marginal Costing concept, fixed costs like rent and salaries come under period costs. They are not directly associated with a specific unit’s production.
Business owners calculate the Marginal Cost to determine their profitability with additional production. This helps them decide how to achieve economies of scale, optimise production, and streamline operations. If the cost of the extra output is less than the per-unit price, the company has a higher chance of gaining a profit.
What are the Advantages of Marginal Costing?
Marginal Cost offers several benefits to a business. Some of the key advantages include the following:
What are the Benefits of Marginal Cost?
After understanding what Marginal Cost is, it’s also essential to understand its benefits. These include the following:
What is the Importance of Marginal Cost?
Those who understand Marginal Cost meaning know that it is a concept of managerial accounting that manufacturers often use to isolate their optimum production level. They can optimise their manufacturing costs by calculating the cost of producing more units to achieve a breakeven point.
When learning how to calculate Marginal Cost, one must include all the variable costs associated with the production level. For instance, if a company builds a new factory to manufacture more goods, it will consider the cost of building as a Marginal Cost. This cost varies according to the volume of goods to be produced.
All in all, Marginal Costing is a crucial factor in economic theory. A company looking for maximum profitability will increase its production until the Marginal Costs equal the marginal revenue. Beyond that level, the additional production costs will exceed the revenue generation.
Types of Costs Involved in Marginal Cost Calculation
The Marginal Cost calculation involves two main parameters:
The formula to calculate the Marginal Costs is as follows:
Marginal Cost = Change in total costs / Change in quantity of output
For instance, if a company produces 1000 pens with an initial total cost of Rs. 50,000, its new total cost will be Rs. 54,000 if it starts producing 100 more units.
What are the Limitations of Marginal Cost Analysis?
Although Marginal Costing offers various advantages, it also has some limitations. These are the most important ones:
Read Also : What is a Cancelled Cheque: How to Write it & Cancelled Cheque?
Conclusion
Understanding the Marginal Cost definition helps identify areas where a company can improve efficiency and reduce costs. By analysing the production process, a business can minimise its production cost per unit, increasing the cash flow and making its products more competitive.
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