What is Total Cost: A Definitive Guide

what are total costs in accounting

There are many different accounting formulas that you will be exposed to as a business owner. One of these is the total cost formula. Calculating your total costs is crucial in better understanding your business’ finances, specifically when it comes to managing profitability.

This guide will break down what total costs are, how to calculate them, and help to understand the differences between certain costs.

What is total cost?

Total costs refer to the overall business costs and expenses incurred when creating goods or services. Everything that your business spends to keep its operations running is accounted for within this financial metric.

Recognizing the various types of costs that arise and their impact on profitability is essential for effective financial management. Therefore, it’s important for small business owners to grasp what total cost means and how to calculate it accurately.

Total cost is made up of two main components.

Total fixed cost vs total variable cost

  • Fixed costs are the costs that remain constant from month to month, regardless of production. This can include rent, salaries, etc.
  • Variable costs are the costs that change over time, depending on the amount of goods or services produced. This can include materials and labour.

The total cost formula

The total cost formula helps businesses calculate the overall expenses involved in producing goods or services. It combines both fixed and variable costs to give a comprehensive view of the financial outlay required for production. Here’s the basic formula:

Total Cost = Fixed Costs + Variable Costs

Total Costs Formula

How to calculate total cost

To properly understand total costs, you need to use the above formula and consider all of your fixed and variable costs. These components together provide a full picture of just how much it can cost to produce your goods or services.

Here’s a simple step-by-step guide:

  1. Determine fixed costs: These are the expenses that remain the same regardless of production levels. Examples include rent, insurance, salaries, and equipment depreciation.
  2. Determine variable costs: These costs change with the level of production. Common variable costs include materials and direct labour costs tied to output.
  3. Add fixed and variable costs together: Once you have both, you can calculate the total cost by adding them together.

Example of total cost in business

We will use an example of a small business that manufactures custom furniture. The company will incur both fixed and variable costs when producing its goods.

In this instance, let’s say that their fixed costs amount to $20,000 per month.

In this instance, let’s say that variable costs per piece of furniture is $200.

If the company produces 100 pieces of furniture in a month, the calculation of total cost would look like this:

  • Fixed costs: $20,000
  • Variable costs: $200 per unit × 100 units = $20,000

So, the total cost for producing 100 pieces of furniture would be:

Total Cost = Fixed Costs + Variable Costs = 20,000 + 20,000 = 40,000

This example illustrates how businesses need to account for both fixed and variable costs to determine the total expenses involved in production – otherwise profitability may not meet your initial expectations.

Example of total cost in business

Importance of calculating total cost for businesses

We have listed several reasons below as to why why accurately calculating your total costs is critical for your business’ success:

1. Set the right price

Understanding total costs allows you to price your business’ products or services appropriately. If costs are underestimated or miscalculated, prices may be low and profitability non-existent. Good calculations allow you to cover expenses and generate decent profits.

2. Profitability analysis

By comparing total costs with revenues, businesses can determine whether they are operating at a profit or a loss. This insight helps in making decisions about scaling production, cutting costs, or adjusting prices.

3. Control and reduce costs

Regularly calculating total cost allows businesses to identify areas where costs can be reduced. For example, they can evaluate whether certain fixed costs, like rent, can be renegotiated, or if variable costs, like raw materials, can be sourced more efficiently. This proactive approach can lead to significant savings over time.

4. Better budgeting and financial planning

Total costs are key for budgeting and financial planning. By forecasting future costs based on current data, businesses can allocate resources more effectively and prepare for upcoming expenses. This helps ensure that the company remains financially stable while pursuing growth opportunities.

5. Improved operational efficiency

When analysing the relationship between fixed and variable costs, companies can find ways to improve production efficiency, such as automating certain tasks or scaling production to reduce per-unit costs.

Keep an eye on your total costs in Brixx

Monitoring your total costs is crucial for making informed business decisions, and with Brixx, it’s easier than ever.

As a financial forecasting tool, Brixx allows you to model your fixed and variable costs, helping you forecast and manage your financial future with precision. Whether you’re planning for growth, controlling expenses, or setting prices, Brixx provides the tools you need to visualise your total costs and optimise your business strategy.

Stay ahead of your finances by keeping a close eye on your total costs in Brixx, ensuring you’re always on the path to profitability and success.

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