This story aims at explaining the formula for average fixed cost clearly. Continue reading to know all about it.
The concept of fixed cost in accounting and economics is very important. Fixed costs are a part of total costs. While discussing them, we should also be aware of what variable costs are. If any one of these concepts are clear to students of accounting, then understanding the other, would not be a big challenge.
Difference Between Fixed and Variable Costs
For any product manufacturing company, dealing with fixed and variable costs is quite common. Any firm would take a decision on increasing or decreasing its production, considering the demand for its products in the market. Though the quality of a company's products may be appreciated by the market, the demand may not be that high, if the consumption pattern itself has undergone change.
Fixed costs are those costs which do not change, despite an alteration in the levels of production. This means that even if the production changes drastically, whether up or down, fixed costs will remain the same.
Exactly opposite to this is the concept of total variable cost, which changes with production levels. These costs will generally rise with increased production and go down significantly with a decrease in production levels.
Fixed costs can be quite a burden for a company when it is not performing well on the sales front. Low sales translate into low revenues, and despite the revenues going down, this cost does not change and cannot be changed.
The company will have to continue spending on such costs, as they are unavoidable. The companies which are able to effectively manage this burden emerge as market leaders and future winners.
Depreciation in machinery cost, overtime paid to workers, payroll taxes of the employer or the company, lubricant costs for machines, cost of tools, and machine costs are the best examples of variable costs.
On the other hand, depreciation on building, insurance to be paid, rent paid to owner, electricity and power expenses, and employee salaries are the examples of fixed costs.
Average fixed cost = Fixed cost of production / Quantity of output produced.
While computing the average fixed costs, you will need the annual reports or the quarterly results of a company, and a calculator. Then using the above formula, you can compute the value.
The information presented above, will help you in analyzing the financial position of a company, and arrive at conclusions, regarding its operational efficiency.