13 Apr What is Cost Function Formula?
The cost function formula allows a company to calculate its total cost of production. It takes into account both fixed costs and variable costs. Using the cost function formula, a manufacturing firm can work out the cost of production at different levels of output or for different product lines.
What does cost function formula mean?
When a company is making its budget, it could use the cost function formula to test different scenarios so that it is in a position to choose the optimum product mix.
C(x) = F + Vx
C = Total cost
F = Fixed cost
V = Variable cost per unit
x = Number of units produced
To understand how the cost function formula works, it’s important to remember that the total cost of production is the sum of fixed costs and variable costs.
Fixed costs remain the same regardless of the level of production. These could include costs like rent, machinery costs, and insurance premiums.
Variable costs increase with a rise in output. Examples of variable costs include material costs, packaging, and labor costs that are directly related to the level of production.
By using the cost function formula, you can calculate the cost of producing various product lines. The company management can then decide on the most profitable way to use its manufacturing resources.
Example of cost function formula
Mollin Industries has two product lines. It manufactures sheet rubber and rubber tubing. While preparing its budget for the following year, it uses the cost function formula to determine the ideal product mix.
The company pays a fixed amount of $18,000 every year towards rent, insurance, and machinery related costs.
The variable costs that Mollin Industries will incur for its two product lines are:
Sheet rubber: $1.75 per foot.
Rubber tubing: $3 per foot.
70,000 feet of sheet rubber or 40,000 feet of rubber tubing can be produced in a year.
The cost function formula yields the following calculation:
Mollin Industries can now factor in its expected sales prices to decide which product it should manufacture to maximize profits.
The cost function formula allows a company to calculate its total cost of production in different manufacturing scenarios. It is a useful tool to help the company’s management estimate total manufacturing costs so that it can decide on an optimum product mix.