What is Average Variable Cost?
Average Variable Cost (AVC) is an accounting tool used to measure the total variable cost per unit of production. In a business environment, there are two types of costs: fixed costs, which are constant and stay the same in the short run, and variable costs, which increase when more production takes place. Unlike fixed costs, which are not affected by volume, variable costs are impacted by the amount of production. Knowing the Average Variable Cost will help businesses and financial managers to make better decisions and accurately assess the profitability of a line of production.
Formula to Calculate Average Variable Cost
The formula for calculating the Average Variable Cost is relatively simple. Total Variable Cost divided by Quantity Produced (TVC/Q) will give you an AVC that you can use to compare different production lines or to assess the efficiency of a particular production process. The key elements in the formula are the Total Variable Cost, a figure that is the sum of all costs incurred for producing the desired output, and the Quantity Produced, which is the number of units produced during the period.
Example of how to Calculate Average Variable Costs
Let’s consider a bakery with a Total Variable Cost of $43 for a given period from the sale of 200 pies. To calculate its Average Variable Cost, we simply divide the Total Variable Cost ($43) by the Quantity Produced (200) = $frac{43}{200}$, which is equal to $0.215. This simple calculation will give you an exact figure of the Average Variable Cost for the production of each pie. In this example, each pie will cost the bakery $0.215 in variable costs.
What is the Difference between Average Variable Cost and Marginal Cost?
Though both Average Variable Cost and Marginal Cost are accounting tools, they provide very different information about the production process. Average Variable Cost measures the total variable cost per unit of production, whereas the Marginal Cost measures the cost associated with the changes in the production of an output. Put simply, Average Variable Cost measures the long-term costs of production, while Marginal Cost looks at the short-term cost associated with producing each extra unit.
In summary, Average Variable Cost is an invaluable tool that helps businesses manage the cost of production. By calculating the Average Variable Cost, businesses can accurately assess the profitability of a line of production, compare different production lines, and make better decisions. Furthermore, understanding the difference between Average Variable Cost and Marginal Cost allows financial managers to differentiate between the long-term and short-term cost of production.
Average Variable Cost Formula Review
Introduction
Average variable cost (AVC) is a useful way of calculating costs for businesses as it offers a comprehensive overview of the financial cost of production. The AVC formula provides the costs associated with producing a single unit of output and is found by dividing total variable costs by the quantity of output. When compared with price, it gives a clear picture on how much it costs to produce a certain item and serves as a useful benchmark for businesses to set prices and understand their profit margins.
How to Calculate Average Variable Cost
The first step in calculating average variable cost is to identify all the variable costs associated with production, such as components, labour, energy, and other inputs. These costs can then be summed together to produce the total variable cost. This total variable cost is then divided by the quantity of output being produced to get the average variable cost per unit.
For example, if a company has a total variable cost of $9 million and produced 6,000 units, the average variable cost per unit would be $1,500 ($9 million / 6,000 units).
Advantages and Disadvantages
Average variable cost is a relatively simple calculation and is easy to understand. This makes it a popular choice for businesses when calculating costs as it provides more of an accurate picture than fixed costs and allows for easier planning. It is also useful for businesses as it helps to identify the optimum level of output to produce in order to maximize profits.
One disadvantage of using AVC is that it does not offer an insight into the cost structure of a business and does not distinguish between different types of input costs. In addition, it does not provide a clear picture of total costs and it does not account for changes in the price of inputs over time.
Conclusion
In conclusion, the average variable cost formula provides an easy to understand picture of the costs associated with producing a certain unit of output. It can be used to aid the understanding of cost structures and aid in the planning of production levels. However, it does have some disadvantages as it does not provide a full picture of total costs and does not account for changes in prices.
