Key business skill: Finance – Costs
When you are considering costing, it is important to consider different kinds of Business Costs, and understanding the distinctions between them will help you “cost out “your product accurately.
Hidden costs are easily forgotten, so your true profit per sale may be lower than you realise. Understanding and allocating costs correctly is key to ensuring you set a selling price that allows you to make a profit.
You may choose to have an accountant look after all of this for you, but you must be able to clearly understand and appreciate what they are discussing with you.
Let us consider the example of a bakery to illustrate some types of cost.
Quick Facts: Finance – Costs
Direct costs are easy to match with a process or product, so for example the ingredients that go into a loaf of bread
Indirect costs are more distant from the product and have to be allocated to a process or product, for example cost of rent for your premises.
Variable costs if your business sells more loaves of bread, some of your costs increase accordingly, such as costs of ingredients
Fixed costs But If your business sells more loaves of bread, your rent will not alter.
Relevant and irrelevant costs not every cost is important to every decision you need to make about your business.
Relevant costs are Costs that should be considered when deciding on a future course of action. Relevant costs are future costs you would incur, if you chose a specific course of action you take. For example, if you increase the number of loaves you produces next year in order to increase your sales, but the cost of flour has just increased. That cost will affect your profit and unless you increase the sales price, could negate the increase in sales volume.so the cost of flour is a relevant cost.
Irrelevant costs are not relevant to your decision on a future course of action, and if you bring them into the analysis, it could cause you to make the wrong decision. For example an expenditure on equipment you have already made, is irrelevant to whether you decide to increase sales.
Actual, budgeted, and standard costs the actual costs your business incurs may differ from its budgeted and standard costs:
Actual costs are historical costs, actual transactions that have already occurred.
Budgeted costs are future costs, for transactions expected to take place over the coming financial period, and they are based on forecasts and established targets.
Standard costs are used mainly in manufacturing, and they are carefully engineered based on an analysis of operations and forecast costs for each component and step in an operation.