How Much Do You Really Know About Marginal Cost?
This cost can define as “the cost added by producing one new unit of a product. “This process allowed us to increase expenditures without tolerating the total price during production.
Meaning of Marginal cost
Marginal costing is the change in the total cost that arises when the production quantity increases by one new unit. It is the cost of one more unit of a good during production. Marginal costing is the cost of additional inputs required to produce the goods at each production level. It includes all costs of production and considered periods that vary with the level of output.
Importance of Marginal Cost
Marginal costing is critical for cost and benefits analysis. It is a cost-benefit study of business activity to see if the additional benefits gained by taking action that values the cost earned. The marginal analysis uses the profit maximization tool that performs a cost-benefit analysis to determine how an incremental change in production volume can affect the business and its profitability.
Features of Marginal Cost
- Marginal costing is used to regulate the minimal cost and the effect of variable costs on output production.
- All costs can be categorized based on the fluctuation in the fixed price and variable value.
- Business costs are treated as the cost of the product during production, while fixed costs are used to establish a Profit and Loss Account for the sustained period.
- Production and Stock of goods are calculated based on Fixed and Variable costs.
- The selling price can be maintained based on average revenue and marginal revenue formula.
- Cost-volume profit analysis and Break-even analysis are essential.
Marginal cost and its benefits
- Fixed and Variable is a simple technique to understand and easy to operate because it reduces the distribution of fixed costs.
- Marginal and average cost comparisons become meaningful in this technique.
- Fixed and Variable costs provide useful data for decision-making.
- The impact of profit on sales variations can be clearly shown.
- The technique goes best with other methods like budgeting control and standard costing.
- It launches a relationship between cost, sales, and output volume and break-even analysis.
Application of Marginal Cost
Following are some of the uses of marginal cost:
- Maintain the desired profit.
- Make or buy decision.
- Fixation of selling prices and contract bidding.
Limitations of Marginal Cost
It has some of the following restrictions:
- The exclusion of costs into fixed and variable elements is very technical and challenging.
- The linear relationship between costs and output is not valid at some activities because the prices do not remain constant at different levels of operations.
- The stock value cannot be accepted by taxation if it collapses profit.
- Decision-making for pricing cannot be based on just contribution.
- The elimination of fixed costs forces cost comparison of production very difficult.
- The distinction between fixed and variable costs holds good only in a short time. In the long run, yet, all prices are unstable.
Usage of Marginal Cost
It is a technique that helps in the decision-making of production and manufacturing goods. It allows organizations to accumulate the trend and market for their production at a manageable cost and generate good profit with less capital.