Unit Cost | Definition, Formula & Examples

Definition of Unit Cost

The simplest way to describe unit cost is the amount of money it takes to produce one unit of whatever you're talking about. Of course, that might be oversimplifying it a little. A giant corporation might build an entire factory to produce a new product with anticipated high demand.

Imagine that a popular shoe company wants to design a new high-end shoe. They might spend millions of dollars on that infrastructure, and it may take years to produce the very first new widget. Literally speaking, the unit cost for the first shoe off that production line might be measured in the millions of dollars. Not even Michael Jordan can afford that! Let's turn now to the much more precise language of mathematics to better explain.

Formula for Unit Cost

The formula for unit cost is often written like this:

UC = c/u

In the equation, c represents the total costs of producing those items, u is the total number of units, and UC is unit cost for the time period. Typically speaking, the number of units is quite easy to calculate, while calculating the costs is more involved. We're going to talk about three types of costs that will go into our calculations: fixed costs, direct labor costs, and direct material costs. To make things confusing, direct labor and direct material costs are also lumped together and called 'variable costs'.

What are those you ask? Well, let's take them one at a time.

Fixed costs are all costs that go into the making of a product that do not vary with the number of units produced. Does the landlord care if your production line was down? No, he's going to expect a rent check regardless of what is happening in your factory. So, rent is a common fixed cost. The same reasoning applies to the cost of equipment used on the production line, property taxes, salaried workers not directly involved with production (such as accountants and management staff), mortgage payments, and insurance payments.

Direct labor costs are limited to the wages paid to workers directly involved with making the product. Those people making shoes in the factory are making salaries figured in to direct labor costs. Managers and executives aren't direct labor costs, remember? They're fixed costs like we talked about earlier.

Direct material costs are also limited to materials purchased and used in making the product. Direct labor and materials are also referred to as variable costs, because they change with the number of units produced.

Sample Calculations

Now let's look at how all of this shakes out in a real life situation. Let's calculate the unit cost of one widget, for Company A, for the month of June, given the following information for that time period:

Units produced = 12,000

Direct labor costs = $35,000

Direct material costs = $25,000

Fixed costs = $22,000

To solve this we use our equation UC=c/u and substitute what we know.

UC = ($35,000+$25,000+$22,000)/ (12,000 units)

UC = $82,000 / 12,000 units

UC = $6.83/unit