When a company produces additional units of goods and services and then calculates the extra costs the same refers to Marginal Cost. It can get calculated by dividing change in costs by change in quantity. The change in quantity depends on inventories. Analyzing the marginal cost of a company provides many benefits.
It includes cost advantages, increased production and help towards making costing decisions. In this article, we will let people be aware of this formula and its uses.
Therefore, it would be easy for both companies and employees to understand the work of this formula. Let’s have a look in detail.
What is Marginal Cost?
Marginal Cost is a fundamental principle in economics theory. As we mentioned earlier, it helps in calculating the extra cost for additional units and services offered by a company.
It can get calculated by dividing change in costs by change in quantity. The marginal costs include all the production items including expenses that change with a particular level of production.
For example, if the marginal cost of additional items produced is lower than the total number of productions then the manufacturer would be able to gain some profit.
Let me explain; some of the benefits of marginal cost.
- Marginal cost assists in concentering resources where excess marginal value over the marginal cost are at its highest.
- It helps evaluate the additional costs. It means it helps the company calculate the additional amount of costs required to produce additional units.
- It helps the company determine the cost advantages through a more efficient production program.
- It helps in decreasing the overall costs of the product line.
- It helps indicate the red factors of whether the company should produce the additional units or not.
How to Calculate Marginal Cost?
Before coming to the calculation part, one should understand the concept of change in quantity and change in costs part. Here we have added an overview for the same.
- Change in costs – It depends. The costs may increase or decrease during production. It occurs when manufacturing is likely to increase or decrease the volume output. For instance, the change in costs is determined by subtracting the cost during productions that occurred during the first output from the cost of productions during the next output run.
- Change in quantity – Production quantity can increase or decrease. The quantity of production should be sufficient to evaluate specific changes in costs. For instance, you can calculate the change in quantity by deducting the number of items made in the first production from the number of items made in the second run.
You may also like to read, What is ESG in Financial Reporting, and What Are the Requirements?
Marginal Cost Formula
The formula to calculate Marginal cost is as follows;
Marginal cost = Change in costs / Change in quantity
You can calculate the marginal cost using the marginal cost formula mentioned above. However, it would be different and all depends on the situation data we have.
For example, a jewellery brand requires 2$ each for the production of necklaces and the jewellery expenses of the factory are fixed at 1500$/month If the factory makes 500 necklaces per month. If the jewellery maker wanted to increase production output volume to 1,000 necklaces per month, then each jewellery item would incur $1.50 of fixed costs.
You are here required to calculate the marginal cost.
Here we come at the end. The marginal cost gets calculated by dividing change in costs by change in quantity. The marginal costs include all the production items including expenses that change with a particular level of production.
In this article, we have added everything one needs to know about this. We hope it helps.