Pricing is one of the most important factors in competition. Those companies with a better business model have an automatic advantage over the competition. The ability to create an equivalent product at a lower cost provides greater operational flexibility as well. You can pass these cost savings on to your clients, purchase higher quality materials, pay your workforce higher wages, pay your investors a higher return, pay down debts faster, etc. No matter what, being able to cut your costs without sacrificing quality is a worthy cause in the business world. Understanding how to calculate your fixed costs, specifically overhead costs per unit, is the first step toward cost reduction.
- Skill level:
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Things you need
- List of Overhead Costs
- Lost of Overhead Expenses
- Number of Direct (salaried) and Indirect Staff
- Average Hourly Wage
- Number of Units Produced in 1 year
Define overhead costs and expenses. These are all costs associated with direct labour and materials. Overhead expenses include accounting, depreciation, interest, legal fees, rent, telephone, taxes and utilities. Basically, anything cost that doesn't change with changes in production output is considered overhead.
Determine average hourly wage. Each employee's contribution should be classified as either direct or indirect labour. Direct labour works directly with product, whereas indirect labour supports direct labour, i.e., accounting or other corporate functions. You are only interested in salaried direct labour and indirect labour.
Estimate the number of workdays available in a given calendar year. Subtract the average number of days labour will not be working (holidays, weekends, vacations, sick leave, etc) from 365.
Multiply the number of workdays available for labour by eight (for an eight-hour work day). This gives you an estimate for the total number of labour hours worked.
Multiply number of total labour hours by average labour wage determined in Step 2.
Add all overhead expenses, as defined in Step 1, to the dollar amount in Step 5. This is your total overhead cost.
Look up the average number of units sold per month and multiply by 12.
Divide total overhead costs by average number of units. This is your overhead cost per unit.
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