How to calculate average spend or cost? Check out this ultimate guide on how to do it! I was recently trying to figure out my own average spend and found the process a bit confusing. But after doing some research, I figured it out and wanted to share what I learned in case anyone else is struggling with the same issue.
How to Calculate Average Spend
In the field of business, several terms refer to the cost of production. When the average person hears the word “average,” they may wonder what it really means.
Professionals often talk about the average cost of production, but people may be confused as to what they’re referring to.
This article discusses the key differences between the average and marginal costs, how to calculate average spend, and why they’re important.
What is Average Total Cost (ATC)?
The average cost of production is the total amount of all production expenses, including labor, materials, and overhead, divided by the quantity or volume of products created. This is also known as unit cost.
In simple terms, average cost measures how much a business spends for each unit of product.
The formula for average total cost is as follows:
Average Total Cost = Total Cost of Production / Quantity of Units Produced.
What to Include in Average Cost
Fixed costs are necessary expenses that do not change regardless of output. For example, the rent on a building or equipment needed to produce a product is considered fixed costs.
Variable costs are expenses that fluctuate based on output. For example, if a company is producing more products, it may need to order more raw materials, which would increase the variable cost.
How to Calculate Average Cost
To calculate the average cost of goods available for sale, you’ll need to divide the total cost of goods by the number of units available for sale. This will give you the average cost per unit that you can use to value your inventory.
1. Determine the Fixed Cost of Production
To calculate the fixed cost, start by looking at the profit and loss statement which can be found in the annual financial report.
The fixed costs of a business include insurance, equipment, rent, loan payments, and any recurring expenses.
2. Find the Variable Cost of Production
The variable costs of production include direct costs like raw materials and labor costs as well as indirect expenses such as packaging and shipping.
3. Add the Total Fixed Costs and Variable Costs
Now that you have the total fixed cost and total variable cost, you can determine the average total cost of production by adding them together.
Average Total Cost = Average Fixed Cost + Average Variable Cost
4. Determine the Number of Units Produced
The number of units produced can be found by referencing invoices, checking with your accounting department, or calling the company that produced the units.
5. Calculate the Average Total Cost of Production
Calculate this cost by dividing the total cost of production (step three) by the number of units that were produced (step four).
Average Total Cost = Total Cost of Production / Quantity of Units Produced
Average Cost vs Marginal Cost
The difference between average cost and marginal cost is that the former is the total expenditure on one unit while the latter is the cost of producing one additional unit.
Follow these three steps to calculate the marginal cost.
1. Calculate Change in Cost
The volume of sales you make often affects your costs. When your sales increase, your operating costs will likely go up.
A decrease in production will result in a decrease in the variable costs associated with it. These variables are related to production and change with it.
To calculate the change in cost:
Change in Cost = New Cost – Old Cost
2. Calculate Change in Quantity
To calculate this, all you need to do is use the same method.
Change in Quantity = New Quantity – Old Quantity
3. Divide Change in Cost By Change in Quantity
When you’re producing and selling goods, your unit price will vary based on the quantity you’re making. The marginal cost of selling 21 sunglasses instead of 20 will likely differ from the marginal cost of selling 101 units instead of 100.
The formula for calculating marginal cost is:
Marginal Cost = Change in Cost / Change in Quantity
Why is Average Cost Important?
Understanding your average total cost is essential when setting your prices. If you sell at a price below the ATC, you will incur a loss.
Understanding how the ATC works over a long period will also help you make better business decisions.
When you average out the cost per unit, it accounts for the fluctuation in costs based on season and demand.
Compare Against Time Periods
Analyze your accounting and sales data, and compare it against your expense reports and other relevant business statistics to see how well your business is doing.
If your business is not making enough daily revenue, review your sales process to see where it can be improved.
If your company’s daily average sales are up from $90 to $110, it may be a sign that your business is gaining more in the market.
You can analyze sales data by division or location to determine which areas are performing the best and which need the most help.
If you’re trying to learn how to calculate average spend, there are a few different methods you can use. The most important thing is to be consistent in how you track your spending so that your results are accurate. Try out a few different methods and see which one works best for you.