Costs and Profits

What is the Economics of One Unit? or How much does it cost to make one of your products?

Entrepreneurs need to know their business is profitable. There is a lot that goes into this equation but the starting point is determining the revenue and profit. We will calculate this from one unit of sale. A unit of sale is what a customer actually buys from you. For example, if you run a hair salon, a unit of sale would be one haircut. If you run a lawn-mowing company, the unit of sale is mowing one lawn.

Let's put it all together. Here is the basic income statement for the Pretzeltastic.

Revenue (Price I am charging the customer) $2.00

- Cost (What it costs to product) .38 (.076 * 5 - the number of pieces in each package)

= Profit (What is left over for the day) 1.62

Now, lets say we want to change the type of candy to create product diversity. In this scenario, the only change to the cost of the product will be the Hershey Kiss becoming a Reese's Peanut Butter Cup.

Revenue (Price I am charging the customer) $2.00

- Cost (What it costs to product) .5555 (.1111 * 5 - the number of pieces in each package)

= Profit (What is left over for the day) 1.4445

The direct costs attributable to the production of the goods sold by a company. This amount includes the cost of the materials used in creating the good along with the direct labor costs used to produce the good. It excludes indirect expenses such as distribution costs and sales force costs.

The examples above purely discuss the Cost of Goods without labor. To add labor we must understand how many we can product with a specific period of time and the labor rate.

It took 1 hour and 20 minutes to produce 220 total units at a rate of $10.00/hr.

1 Hour = $10.00

20 Minutes = 20 minutes / 60 minutes = 1/3 an hour * $10.00 = $3.33

1:20 = $13.33

The unit of one good costs: $13.33 / 220 = .06059 in labor costs.

Pretzeltastic with Hershey total COGS = .076 + .06059 = .1366

Pretzeltastic with Reece's Peanut Butter Cup = .1111 + .06059 = .1717

The good news is you do not need to calculate the cost of labor for your good.

Economies of scale exist when companies begin to mass product goods. Think of Costco. Does Costco spend more for a bottle of Ketchup or does your local gas station? Costco gets the ketchup cheaper because the buy a great deal more. The ketchup manufacturer relies on Costco to buy large values to product revenue for the ketchup manufacturer. Therefore, they provide incentive to Costco by selling to them at a discounted rate. The same is true in most businesses.

In general it is a lot cheaper to product 100,000 cars than 100.

Vocabulary

• Break-Even Point
• COGS (Cost of Goods Sold)
• Economics of One Unit
• Economy of Scale
• Fixed Expenses
• Variable Expenses

Additional Reading

Student Activity

Part 1

• How Much Does it Cost to Produce and Iphone?
  • Breakdown the selling price, cost, and profit
  • How does this compare to the average product made by Apple?
  • What is the difference between a non-contract purchased iPhone and contract purchased iPhone?
  • Who is eating the cost on a contract iPhone?

Part 2

• Compare the Selling price, cost and profit of the iPad to the iPhone.
  • The average profit margin for apple is 38%
  • What does this profit margin of the iPad and the iPhone tell us about the rest of Apple's Products?

Part 3

• How much does it cost to produce the Amazon Kindle?
  • Breakdown the selling price, cost and profit of the Kindle
  • How does this compare to the average Income Statement for Amazon?
  • How can Amazon sell the Kindle at a loss?