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How to Cost Products
You must know what it costs to produce your product or service in order to determine what you are spending to make individual products and services. This means that your financial system must be set up to account for your costs in sufficient detail to allow you to make decisions based upon the data you receive. If you are lumping all of your expenses together, there is no way you can make decisions as to what resources are being allocated to what products and whether those resources are being utilized efficiently for your company. Some basic elements which must be present in order for you to be able to perform proper allocations of cost to your products are a complete understanding of the types of expenses you incur. Typical expense categories which you must be able to identify include:
| a. |
fixed expenses such as rent that cannot be reduced, |
| b. |
semi-variable or incremental expenses that do not vary in direct relationship to increases in activity or sales but will increase at some
point |
| c. |
variable expenses that vary directly with sales or revenues, such as the cost of producing a publication, and |
| d. |
overhead and support costs allocated to various activities. As payroll will be your largest support cost, the easy way to allocate payroll is to have all staff maintain timesheets that allocate all their time to the various activities to which they are responsible for including the products. The time will be charged on the basis of total hours worked times a fixed rate which is developed by dividing total payroll costs, salaries and fringe benefits by a 40-hour work week for the entire year (or 2,080 hours). |
All costs including your fixed overhead must be allocated to products on some basis. There are many different ways to do this. Some do it on the basis of revenue generated and resources used such as staff-allocated payroll costs.
Once you have completed all this analysis, you can make a determination as to where resources should be allocated and what the true bottom line is for all your products. If you reallocate resources to higher profitability areas, you will benefit your company in the long run.
The second thing you should be doing is looking at those activities that do achieve or make significant contribution towards the vision of your organization but are not contributing to the bottom line. Each one of these activities should be dissected and analyzed to determine what could be done to move it to a category of profitability while still maintaining the benefits to the organization.
Ask the following questions:
- What is the product’s current gross margin?
- What is the product’s variable cost in relationship to value?
- As quantity increases, does the gross margin increase?
- As price increases, how much will volume decrease?
We have reviewed the importance of knowing what you sell, what it costs and how prices impact your profitability. How can some of these ideas be used in your business? Remember let’s use a little “break-it” type thinking. Just because we or others in our business are not doing something doesn’t mean you shouldn’t.
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