Average Fixed Cost Formula (Table of Contents)
What is the Average Fixed Cost Formula?
Fixed costs are expenses that do not change with the change in production. In other words, the company will still have these expenses irrespective of the increase or decrease in the goods or services produced by the company. In Managerial Accounting the term Average Fixed Cost is used to calculate the total cost that should be allocated to each unit produced. Keeping everything else constant increase in production means a decrease in the Average Fixed Cost. Similarly, if the company produces lower units the average fixed cost per unit will increase.
Mathematically, it is represented as,
Examples of Average Fixed Cost Formula (With Excel Template)
Let’s take an example to understand the calculation of Average Fixed Cost in a better manner.
Average Fixed Cost Formula – Example #1
Let us take the example of a company that produces 20,000 units of goods every two months. Below is the list of monthly expenses that the company has to pay in order to produce these goods –
To produce 20,000 the company has to pay rent of $4000 for the manufacturing unit, $900 for property tax, $700 has to be paid for insurance, $5000 is spent every month in paying administrative wages and $2000 is paid as depreciation expense on the machinery. This would have the total expense as $12,600 and since we are calculating for two months the total expense would be $25,200.
Total Fixed Cost For 2 months is calculated as
- Total Fixed Cost = $4,000 + $900 + $700 + $5,000 + $2,000
- Total Fixed Cost = $25,200
Average Fixed Cost is calculated using the formula given below
Average Fixed Cost = Total Fixed Cost / Quantity of Units Produced
- Average Fixed Cost = $25,200/ 20,000
- Average Fixed Cost = $1.26 per unit
Average Fixed Cost Formula – Example #2
Let us take another example of John who has recently started his own firm XYZ and is trying to identify the method to calculate the total fixed cost. He knows about the method which uses total cost and variable cost to calculate the fixed cost. In this method, we first have to figure out the total cost which is the addition of both fixed and variable costs
Average Total Cost is calculated as
Average Total Cost = Total Cost / Quantity of Units Produced
- Average Total Cost = $14,100 / $20,000
- Average Total Cost = $0.71
In calculating the total cost every element should be considered. In our above example the total costs come out to be $14100 and the total units sold are 20,000 bringing the average total costs to $0.71.
In order to find out the fixed costs, we have to first determine the variable cost from the total costs. In our example the variable costs are – Materials, Utilities, Manufacturing wages and Marketing
- Total Variable Cost = $500 +$200 + $500 + $300
- Total Variable Cost = $1,500
- Average Variable Cost = $1,500 / $20,000
- Average Variable Cost = $0.08
Using the total variable cost and the total units the average variable costs come out to be $0.08
Average Fixed Cost is calculated using the formula given below
Average Fixed Cost = Average Total Cost – Average Variable Cost
- Average Fixed Cost = $0.71 – $0.08
- Average Fixed Cost = $0.63
Now using both these numbers we will calculate the total fixed costs by subtracting the variable cost from the fixed cost. In our example, we will subtract $0.08 from $0.71 to get the average fixed cost of $0.63.
Average Fixed Cost Formula – Example #3
Let us take the example of Stella who has recently given up her job and has started her firm. She wants to understand the break-even point of her new business and wants to use average fixed and variable costs, the price for the same.
She plots the units, fixed cost, and profit on a graph (as shown below) –
Char for the given data –
She makes the following observations –
- The products price is always set above the average variable costs the remaining is then used to cover for the fixed costs
- Average fixed costs can be used to determine how and where to cut expenses. Reducing fixed costs provides more operative leverage, this will also help in lowering the sales need to reach a break-even
- By determining the average fixed costs at various levels you will be able to figure out how much profit you will be able to make by producing more
The formula for average fixed cost can be derived by using the following steps:
Step 1: Firstly, figure out the total fixed cost of the company. It is the top line item in the income statement. A few examples of fixed costs are rent, selling charges, depreciation, property taxes, salaries, interest expense, etc. Sum all of these to get the total fixed cost
Step 2: Next, determine the number of units produced. The details of this can be found either in the income statement or the notes to financial statements.
Step 3: Finally, the formula for average fixed cost can be derived by dividing the total fixed cost (step 1) and the total quantity cost (step 2)
Relevance and Uses of Average Fixed Cost Formula
Just by looking at the costs investors or economists do not get the entire picture of the firm, to discover little more they want to understand how the firm operates so they look at the relationship between the fixed cost and quantity. To do so they divide the fixed cost with quantity to get the average costs.
These average costs help in determining the efficiency of production and most importantly in determining the economies of scale. By plotting the units, average fixed, variable and fixed costs on the graph with the total units sold for a particular time period helps in determining the break-even point of the firm and till when the firm wants to achieve economies of scale.
Average Fixed Cost Formula Calculator
You can use the following Average Fixed Cost Calculator
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This is a guide to Average Fixed Cost Formula. Here we discussed how to calculate Average Fixed Cost Formula along with practical examples. We also provide an Average Fixed Cost calculator with a downloadable excel template. You may also look at the following articles to learn more –
- Formula For Profit Percentage
- How to Calculate Quartile Deviation Formula
- Example of Bank Reconciliation Formula
- Calculation of Net Interest Margin