What Is the Marginal Cost of Production?

In economics, the marginal cost of production is the change in total production cost that comes
from making or producing one additional unit. To calculate marginal cost, divide the change in
production costs by the change in quantity. The purpose of analyzing marginal cost is to determine
at what point an organization can achieve economies of scale to optimize production and overall
operations. If the marginal cost of producing one additional unit is lower than the per-unit price,
the producer has the potential to gain a profit.

The marginal cost of production is an economics and managerial accounting concept most often
used among manufacturers as a means of isolating an optimum production level. Manufacturers
often examine the cost of adding one more unit to their production schedules. At a certain level of
production, the benefit of producing one additional unit and generating revenue from that item will
bring the overall cost of producing the product line down. The key to optimizing manufacturing
costs is to find that point or level as quickly as possible.

Production costs consist of both fixed costs and variable costs. Fixed costs do not change with
an increase or decrease in production levels, so the same value can be spread out over more units
of output with increased production. Variable costs refer to costs that change with varying levels
of output. Therefore, variable costs will increase when more units are produced.

For example, consider a hatmaker. Each hat produced requires seventy-five cents of plastic and
fabric. Plastic and fabric are variable costs. The hat factory also incurs $1,000 dollars of fixed costs
per month. If you make 500 hats per month, then each hat incurs $2 of fixed costs ($1,000 total
fixed costs / 500 hats). In this simple example, the total cost per hat would be $2.75 ($2 fixed cost
per unit + $.75 variable costs).

If the hatmaker cranked up production volume and produced 1,000 hats per month, then each hat
would incur $1 dollar of fixed costs ($1,000 total fixed costs / 1,000 hats), because fixed costs are
spread out over an increased number of units of output. The total cost per hat would then drop to
$1.75 ($1 fixed cost per unit + $.75 variable costs). In this situation, increasing production volume
causes marginal costs to go down.
Variable cost per unit = BDT 25
Fixed cost = BDT 1,00,000
Cost of 10,000 units = 25 × 10,000 = BDT 2,50,000
Total Cost of 10,000 units = Fixed Cost + Variable Cost
= 1,00,000 + 2,50,000
= BDT 3,50,000
Total cost of 10,001 units = 1,00,000 + 2,50,025
= BDT 3,50,025
Marginal Cost = 3,50,025 – 3,50,000
= BDT 25

What are Overhead Costs?

Overhead costs, often referred to as overhead or operating expenses, refer to those expenses
associated with running a business that can’t be linked to creating or producing a product or
service. They are the expenses the business incurs to stay in business, regardless of its success
level.

Overhead costs are all of the costs on the company’s income statement except for those that are
directly related to manufacturing or selling a product, or providing a service. A potter’s clay and
potting wheel are not overhead costs because they are directly related to the products made. The
rent for the facility where the potter creates is an overhead cost because the potter pays rent whether
she’s creating products or not.

A company’s overhead costs depend on the nature of the business. A retailer’s expenses will be
different from a repair shop or a crafter’s. Typical examples include:
 Rent
 Utilities
 Insurance
 Salaries that aren’t job- or product-specific
 Office equipment such as computers or telephones
 Office supplies
Types of Overhead
Overhead expenses may apply to a variety of operational categories. General and
administrative overhead traditionally includes costs related to the general management and
administration of a company, such as the need for accountants, human resources, and receptionists.
Selling overhead relates to activities involved in marketing and selling the good or service. This
can include printed materials and television commercials, as well as the commissions of sales
personnel.

Depending on the nature of the business, other categories may be appropriate, such as research
overhead, maintenance overhead, manufacturing overhead, or transportation overhead.

To calculate the overhead rate, divide the total overhead costs of the business in a month by its
monthly sales. Multiply this number by 100 to get your overhead rate.
For example, say your business had $10,000 in overhead costs in a month and $50,000 in sales.
Overhead Rate = Overhead Costs / Sales
The overhead rate is $10,000 / $50,000 = .2 or 20%
This means that the business spends twenty cents on overheads for every dollar that it makes.

To allocate the overhead costs, you first need to calculate the overhead allocation rate. This is
done by dividing total overhead by the number of direct labor hours.

For example, if the total overhead for making a product is $500 and the total direct labor hours is
150 hours, the overhead allocation rate is:
Overhead allocation rate = Total overhead / Total labor hours
$500/150 = $3.33
This means for every hour needed to make a product, you need to allocate $3.33 worth of overhead
to that product.
What Is Cost-Volume-Profit – CVP Analysis?
Cost-volume-profit (CVP) analysis is a method of cost accounting that looks at the impact that
varying levels of costs and volume have on operating profit. The cost-volume-profit analysis, also
commonly known as break-even analysis, looks to determine the break-even point for different
sales volumes and cost structures, which can be useful for managers making short-term economic
decisions.

The cost-volume-profit analysis makes several assumptions, including that the sales price, fixed
costs, and variable cost per unit are constant. Running this analysis involves using several
equations for price, cost and other variables, then plotting them out on an economic graph.
Cost-Volume-Profit Analysis Formula Is
The CVP formula can be used to calculate the sales volume needed to cover costs and break even,
in the CVP breakeven sales volume formula, as follows:
Breakeven Sales Volume = FC/CM
Where:
FC = Fixed costs
CM = Contribution margin = Sales−Variable Costs
The contribution margin is sales revenue minus all variable costs. It may be calculated using dollars
or on a per unit basis. If the Three M's, Inc., has sales of $750,000 and total variable costs of
$450,000, its contribution margin is $300,000. Assuming the company sold 250,000 units during
the year, the per unit sales price is $3 and the total variable cost per unit is $1.80. The contribution
margin per unit is $1.20. The contribution margin ratio is 40%. It can be calculated using either
the contribution margin in dollars or the contribution margin per unit. To calculate the contribution
margin ratio, the contribution margin is divided by the sales or revenues amount.
Break-even point
The break‐even point represents the level of sales where net income equals zero. In other words,
the point where sales revenue equals total variable costs plus total fixed costs, and contribution
margin equals fixed costs. Using the previous information and given that the company has fixed
costs of $300,000, the break‐even income statement shows zero net income.

Break‐even point in dollars. The break‐even point in sales dollars of $750,000 is calculated by
dividing total fixed costs of $300,000 by the contribution margin ratio of 40%.

Another way to calculate break‐even sales dollars is to use the mathematical equation.
In this equation, the variable costs are stated as a percent of sales. If a unit has a $3.00 selling price
and variable costs of $1.80, variable costs as a percent of sales is 60% ($1.80 ÷ $3.00). Using fixed
costs of $300,000, the break‐even equation is shown below.

Break‐even point in units. The break‐even point in units of 250,000 is calculated by dividing
fixed costs of $300,000 by contribution margin per unit of $1.20.

The break‐even point in units may also be calculated using the mathematical equation where “X”
equals break‐even units.
What Is Relevant Cost?
Relevant cost is a managerial accounting term that describes avoidable costs that are incurred only
when making specific business decisions. The concept of relevant cost is used to eliminate
unnecessary data that could complicate the decision-making process. As an example, relevant cost
is used to determine whether to sell or keep a business unit. The opposite of a relevant cost is
a sunk cost, which has already been incurred regardless of the outcome of the current decision.
Example of Relevant Cost: Assume, for example, a passenger rushes up to the ticket counter to
purchase a ticket for a flight that is leaving in 25 minutes. The airline needs to consider the relevant
costs to make a decision about the ticket price. Almost all of the costs related to adding the extra
passenger have already been incurred, including the plane fuel, airport gate fee, and the salary and
benefits for the entire plane’s crew. Because these costs have already been incurred, they are sunk
costs or irrelevant costs. The only additional cost is the labor to load the passenger’s luggage and
any food that is served mid-flight, so the airline bases the last-minute ticket pricing decision on
just a few small costs.

What Is Capital Budgeting?

Capital budgeting is the process a business undertakes to evaluate potential major projects or
investments. Construction of a new plant or a big investment in an outside venture are examples
of projects that would require capital budgeting before they are approved or rejected.

As part of capital budgeting, a company might assess a prospective project's lifetime cash inflows
and outflows to determine whether the potential returns that would be generated meet a sufficient
target benchmark. The capital budgeting process is also known as investment appraisal.

Understanding Capital Budgeting

Ideally, businesses would pursue any and all projects and opportunities that enhance shareholder
value and profit. However, because the amount of capital or money any business has available for
new projects is limited, management uses capital budgeting techniques to determine which projects
will yield the best return over an applicable period.

Although there are numerous capital budgeting methods, below are a few that companies can use
to determine which projects to pursue.

How Capital Budgeting Works

When a firm is presented with a capital budgeting decision, one of its first tasks is to determine
whether or not the project will prove to be profitable. The payback period (PB), internal rate of
return (IRR) and net present value (NPV) methods are the most common approaches to project
selection.
Although an ideal capital budgeting solution is such that all three metrics will indicate the same
decision, these approaches will often produce contradictory results. Depending on management's
preferences and selection criteria, more emphasis will be put on one approach over another.
Nonetheless, there are common advantages and disadvantages associated with these widely used
valuation methods.