Why Knowing Is Important
We should all know that when it comes to the economy, anything is possible. Some businesses vanished during the 2008 economic downturn, others survived – and some actually flourished! Those that survived and those that flourished had one thing that others did not: an understanding of their product cost. While many businesses are seeing their sales volumes return to pre-2008 levels, I wonder how many of them truly know what it costs to produce their products.
What Goes Into Product Cost?
I have found that the vast majority of small- to mid-size companies do not totally understand, nor compute, their true product costs. Most can tell me what their raw materials cost and can give me an average wage cost. But, they don’t know their overhead and how to properly allocate it to each product or product line. Then, there are many people who think that, by simply purchasing a piece of software, the costing of each product will become automatic. Not true!
Product costing isn’t just a consideration for manufacturers. Whether you make widgets or sell your services, product costs impact your bottom line. If you provide services, your product is your time. What goes into that time? Your salary, obviously, but also your overhead costs and the costs of anything that you consume in that time, be it gasoline or office supplies.
Why is Product Costing Important?
None of us in business want to lose money; we all want to make sure that we’re profitable.
PROFIT = REVENUE – EXPENSES
Without understanding our product costs, we can’t figure out if our products are profitable or what we can to do to make them profitable.
Understanding product costing doesn’t have to be difficult. To begin, you need to develop a costing model that fits your company. One of the key components is determining how to allocate costs among your company’s various products. What is your cost driver? You then need to determine units of measure. Once you determine how costs will be calculated and allocated, you need to determine the ways in which costs fluctuate. Armed with this information, you have the basics needed to create a product costing model.
Another item to consider is the reporting function of cost accounting. What types of reports are needed and at what frequency? And, what are you doing with the information? Knowing what information you’ll need later will help you to start tracking the right data now.
Do You Need Help with Product Costing?
With a depth of experience in product costing, Rea’s manufacturing accounting team can help you to get a handle on your costs … and on your profits. Specifically, we can:
- Evaluate your current costing methodology
- Define your direct costs, indirect costs and overhead
- Walk through your processes to determine your correct cost drivers
- Assist you in determining what reports you should generate in regards to product cost
Contact Rea’s accounting team if you need help with evaluating your business’s true product costs.
By: Tom Scharf, CPA/ABV, CVA, CFF, MAFF (retired)