Costing: Introduction and Types

INTRODUCTION COSTS DEFINED Cost - All the money that is spent to manufacture a product or to provide a service. Opportunity Cost - Is the loss of the benefit that could have been obtained by investing resources (cash, salaries, time) in something else. TYPES OF COST Fix...

INTRODUCTION COSTS DEFINED Cost - All the money that is spent to manufacture a product or to provide a service. Opportunity Cost - Is the loss of the benefit that could have been obtained by investing resources (cash, salaries, time) in something else. TYPES OF COST Fixed Cost - Costs that are not dependent on the level of production or sales. Variable Cost - Costs that change in proportion to the activity of a business. Total Costs - The total costs of a product are the sum of the variable and fixed costs. Marginal Cost - The change in the total cost that occurs when the quantity produced changes by one unit. Direct Costs - Costs that can be directly associated with a particular cost area. Indirect Costs - Costs that cannot be traced to a single cost object. Incremental Cost - The change in cost caused by a particular managerial decision. Overhead Costs (Overhead) - Costs that are necessary to the continued functioning of the business. Operating Costs - Recurring costs which are related to the operation of a business. MARGINAL COST AND MARGINAL REVENUE Marginal Cost - The extra cost of producing one more unit of output or service. Marginal Revenue - The incremental amount of revenue generated by additional unit of output. The shape of the MC curve is directly attributable to increasing, then decreasing marginal returns and the law of diminishing returns. Law of Diminishing Returns - In a production system with fixed and variable inputs, beyond some point of production, each additional unit of variable input yields less and less output. Marginal Profit - The dollar amount by which a food company’s profit increases or decreases when output increases by one unit. Contribution Margin - The marginal profit per unit sale. Break-Even Point - The point at which cost or expenses and revenue are equal. (TR=TC) COST ANALYSIS Cost Analysis - The process of undertaking a cost analysis usually starts with the identification of the fixed and variable costs in each company.  The Bill of Materials - Internal document that will specify all the “direct” inputs into a product. Optimal Production Level - In order to determine the optimal level of production will require an analysis of production levels and costs over time. Blended Cost - Best production blend that results in the lowest possible total cost for the range of products produced by the company while maximizing line efficiency and profitability. Cost Drivers - Any activity that causes a cost to be incurred. COST MANAGEMENT Cost Management - A focus on the continuous control of costs in all parts of a company. Asset Efficiency - Most companies have most of their liquid assets tied up in the following areas. Reducing the amount of cash tied up in each are can have a significant impact on cash flow and profitability. o Accounts Receivable and Accounts Payable - Target AR to 30-45 days and target AP to 45-60-90 days o Finished Good Inventory - Review levels against order fill rates. How long does the inventory sit in stock; target annual stock turns. o Raw Materials Inventory - What levels are required to meet production needs; is there a Just in Time program in place and what are the terms of sale Transaction Costs - Companies often do not know what it costs to mail an envelop, service a customer by phone or issue an invoice. o Customer Service - Review CS costs per customer, costs of order input and service order size, service requirements, management time, and system time. o Invoicing - Can cost $21.00 to issuance an invoice. o Accounts Payable - Can cost $20-$60 to pay an invoice. o Purchasing - Issuance of purchase orders, reconciliation of orders, tracking and monitoring of orders. Portfolio Management - Not all products deliver the same margin or net profits to a company. Strategic and Counter Sourcing - Many companies get caught in the sourcing trap. Outsourcing - Every food company has their own core competency. Unprofitable Products Review and Eliminate - In many food companies the adage is “more is better”. Vendor Program Review - Many food companies rarely review vendor programs with a view to reducing costs. PRICING Pricing - Often a problem for many businesses.  Cost Determination - Pricing without elementary cost data is usually done at a company’s peril. Pricing Strategies - A sometimes overlooked part of the marketing mix. PRIMARY STRATEGIES Market Penetration Pricing - A pricing strategy that is intended to break down existing consumer brand preferences. Price Skimming (Creaming) - A pricing strategy commonly used by start-ups. Market Stability - A pricing strategy is used to ensure the stability of prices in a market. Margin Capture - A strategy is used for specialty products where it is anticipated that the sales volumes will be low or intermittent. Differentiation - A common strategy used to create market awareness and establish a position in the market. SECONDARY OBJECTIVES Standard or Uniform List Price - Same price list is used for all customers. F.O.B. (Plant/Ex Factory/Warehouse /Store) - Free on Board. Zone Pricing - Retail strategy to set local prices to match competition. Bundle Pricing - Practice of bundling a group of like products together to create a market bundle for discounts. Line Pricing - The practice of charging one price for family products. Competitor or Follow the Leader Pricing - Involves using the price of competitor’s products to determine price. Survival Pricing - Products are sold at cost in order to generate cash flow. COMPETITIVE PRICING / DISTRIBUTION ANALYSIS Competitive Pricing / Distribution Analysis - Unfortunately, most competitors will not readily provide you with their pricing strategy. Retail Margin - The amount of gross profit made when a product is sold. Retail Markup - The difference between the cost of a good or service and its selling price. Competitive Positioning - Pricing is one of the key determinants of a retail products position. SETTING THE PRICE Setting the Price - Setting the List or Opening Price is both an art and a science. Value Base Pricing - Setting the price based on the perceived value to the consumer. Psychological Pricing - Setting the price on factors such as perception of quality.  Customary Price Points - Setting the price points in the range that consumers are used to paying for a type of product. Substitution Pricing - Setting the price point so that substitutable products do not have an advantage. CHAPTER 2: COSTS - CONCEPTS AND CLASSIFICATIONS MANUFACTURING COSTS / PRODUCT COSTS / INVENTORIABLE COSTS: Direct Materials - Basic ingredients transformed into finished products. Direct Labor - Wages paid to workers directly involved in product creation. Factory Overhead - Catchall for manufacturing costs not classified as direct materials or direct labor. NON-MANUFACTURING COSTS/PERIOD COSTS Marketing or Selling Expense - Costs to secure customer orders and deliver products. General or Administrative Expense - Executive, organizational, and clerical expenses not related to production or marketing. COSTS CLASSIFIED AS TO VARIABILITY Variable Costs - Costs that vary directly with the volume of production. Fixed Costs - Costs that remain constant in total, regardless of production volume. Committed Fixed Costs - Long-term commitments made by management. Managed Fixed Costs - Costs incurred on a short-term basis and more easily modified. Mixed Costs - Costs with both fixed and variable components. Semi-Variable Costs - Costs with a fixed minimum fee plus variable usage charges. Step Costs - Fixed costs that change abruptly at different activity levels. COSTS CLASSIFIED AS TO RELATION TO MANUFACTURING DEPARTMENTS Direct Departmental Charges - Costs directly charged to the department that incurred them. Indirect Departmental Charges - Costs initially charged to other departments and later allocated to the benefiting department. COSTS CLASSIFIED TO THEIR NATURE AS COMMON OR JOINT Common Costs - Costs shared by two or more operations, commodities, or services. Joint Costs - Costs incurred in the simultaneous manufacture of multiple products. COSTS CLASSIFIED AS TO RELATION TO AN ACCOUNTING PERIOD  Capital Expenditures - Expenditures benefiting multiple accounting periods, recorded as assets. Revenue Expenditures - Expenditures benefiting only the current period, recorded as expenses. COSTS FOR PLANNING, CONTROL, AND ANALYTICAL PROCESSES Standard Costs - Predetermined costs used as benchmarks for budgetary control. Opportunity Cost - The benefit forgone when choosing one alternative over another. Differential Cost - Cost difference between two alternatives. Relevant Cost - Future cost that changes across alternatives. Out-of-Pocket Cost - Cost requiring the payment of money or assets. Sunk Cost - Cost incurred for a past decision, not relevant for future decisions. Controllable Cost - Cost that a specific level of management has the authority to authorize.