In accounting, marginal costing is a method of tallying the costs it takes to produce goods. Conventional systems use a complete costing system that combines variable costs and fixed costs. Variable costs are costs that change based on the number of products that are created. Expenses for supply materials, for instance, will change based on the number of units produced. Fixed costs are the basic costs of running an operation that do not change no matter how many products are made. Marginal costing differs from more complete versions because it applies only variable costs to the production cost analysis and leaves out fixed costs. This is a very common tactic manufacturers use when they are looking for ways to save money.
Manufacturers often aim to increase economies of scale when they make future plans. In other words, the greater the number of units produced, the more efficient that production becomes. Money is saved through repetition of the process. The business becomes better at it, making units faster and more efficiently. This leads to lower variable costs for each product. Marginal costing is a very effective way of measuring whether economies of scale are saving the business money.
From a broader perspective, marginal costing is ideal when making key decisions about a business. Without marginal costing, a manager must remove fixed costs from the analysis to be able to see how a particular change in equipment or factory layout might effect production. Marginal costing simply takes this step away, allowing business leaders to see at a glance how a change would affect the cost of a single unit. This helps businesses create strategies much more quickly and make necessary decisions with minimal research.
Marginal costing does have some associated disadvantages. For instance, the fixed costs have to go somewhere if they are not included on the marginal costing report. They are often pushed aside to the profit and loss statement. However, these costs do not go away and must eventually be accounted for, which can change production costs significantly. Also, for tax purposes, most manufacturers must include information on both variable and fixed costs in all financial documents.
Marginal costing also runs into difficulties when forecasting is involved. The whole point of marginal costing is to show the business how it could save money per unit or batch. But the business only has past data to work with -- data that was probably gathered when equipment was newer or different, or when different employees worked at the factory, for example. Inevitable changes make it difficult to fully predict a company's future costs.