What is Average Fixed Cost?

//What is Average Fixed Cost?
What is Average Fixed Cost? 2017-09-30T06:43:30+00:00

Definition: Average fixed cost is a management accounting formula that measures the fixed production expenses per good produced by dividing total fixed-costs by number of units produced.

What Does Average Fixed Cost Mean?

What is the definition of average fixed costs? Fixed costs are defined as the expenses that are independent of the number of goods or services a business produces. In other words, the company will have these expenses regardless the amount it produces or sells. If the company sells one unit or 200,000 units, these expenses will stay the same.

Managerial accountants use the average fixed cost formula to calculate how much costs should be allocated to each unit of production.

As the number of units produced becomes larger, the average fixed costs per unit becomes smaller, all else equal. Similarly if a business produces fewer units, the average cost would increase per unit.

Let’s look at an example.

Example

Linda, an entrepreneur, works from home making personalized dolls and crafts for users through an online platform. Linda hires two family members to help with accounting and order management. Since they work from home, Linda’s fixed costs include rent, utilities, salaries, and cost of operating through the platform totaling $9,500 per month.

Last month, she made 96 original works and sold them through the platform. Thus, Linda would have a average cost per unit of $98.96 ( $9,500 / 96 units ).

This number will help her determine the minimum profit she must earn per product to be at least pay all of her expenses. Keep in mind, this calculation doesn’t take into account variable costs associated the production of each unit like materials or shipping. Linda will have to figure in these expenses in her overall pricing structure to make sure that can keep producing dolls.

For instance, if each doll required $25 of materials, it would cost a total of $123.96 to produce each doll. Thus, Linda must sell them for at least $124 to break even and even higher than that if she wants to pay herself.

Summary Definition

Define Average Fixed Costs: Average fixed cost means fixed expenditures per unit produced by a company.