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Product costing methods for business success

Have you ever opened your banking app and been struck with a wave of panic? Or found yourself staring at your phone screen in utter bewilderment, wondering where all your money went? These are all-too-common experiences that can be easily remedied with a well-implemented product costing system.

While personal finance can be daunting, the stakes are even higher when it comes to running a successful business. Without a solid understanding of where your expenses are going, you risk losing money and valuable resources.

That’s why product costing is a vital component of any thriving business. This article delves into the intricacies of product costing to help you gain a deeper understanding of its importance.

Table of contents

What is product costing, importance of product costing, product costing methods, how to find product cost, activity-based costing vs. product costing, accounting for product cost, how katana helps with product costing.

Product costing is the process of calculating the comprehensive expenses associated with creating or acquiring a product, including direct costs like raw materials and labor, as well as indirect costs such as overhead and administrative expenses. By meticulously accounting for all cost components, product costing provides a holistic understanding of the true production expenses, allowing companies to set appropriate prices that cover costs and generate a profit.

Having precise and up-to-date product costing information empowers companies to make well-informed decisions about pricing strategies, production quantities, and resource allocation. With this valuable insight, businesses can determine the most cost-effective ways to produce goods, identify areas for cost reduction, and optimize their operations to drive profitability and competitiveness in the market.

Additionally, product costing plays a crucial role in budgeting, financial forecasting, and assessing the financial viability of product lines or projects, giving businesses a comprehensive view of their financial health and aiding in long-term planning.

Let’s take a closer look at the importance of product costing and the benefits it brings.

Product costing plays a pivotal role in the success and financial health of any business, regardless of its size or industry. It serves as a critical tool that enables companies to make informed and strategic decisions that can directly impact profitability and overall business performance. Here are some key reasons why product costing is of paramount importance:

• Accurate pricing — Product costing allows businesses to determine the true cost of manufacturing or acquiring a product. With precise cost data, companies can set appropriate prices that cover production expenses and provide a reasonable profit margin. This prevents underpricing, which can lead to losses, or overpricing, which may deter potential customers.
• Cost control and efficiency — By analyzing the detailed costs involved in the production process , companies can identify areas of inefficiency and take measures to control expenses. Whether it’s optimizing raw material usage, streamlining production processes, or reducing overhead costs, product costing provides insights that drive cost-saving initiatives and boost overall efficiency.
• Resource allocation — Understanding the cost breakdown of each product helps companies allocate their resources wisely. They can focus on high-margin products or those with strong market demand while phasing out less profitable ones. This strategic allocation ensures that resources are channeled where they can yield the highest returns, maximizing the company’s profitability.
• Budgeting and financial planning — Product costing provides a solid foundation for creating budgets and forecasting financial performance. Accurate cost estimates help businesses set realistic revenue targets, plan investments, and assess the financial feasibility of new product developments or business expansions.
• Competitive advantage — In a highly competitive market, having a comprehensive understanding of product costs can be a significant differentiator. Businesses that are adept at managing costs can offer competitive prices while maintaining healthy profit margins, positioning themselves favorably in the market.
• Decision-making — Product costing empowers management with valuable insights when making critical decisions. Whether it’s choosing between in-house production and outsourcing , introducing new product lines, or discontinuing unprofitable ones, the data-driven decision-making facilitated by product costing ensures well-considered choices that align with business objectives.
• Performance evaluation — Comparing actual costs to estimated costs helps in evaluating the performance of different product lines or production processes. Businesses can identify areas that need improvement, set performance benchmarks, and incentivize teams to achieve cost-saving goals.
• Financial transparency — Accurate product costing enhances financial transparency within the organization. It enables stakeholders, investors, and lenders to have a clear picture of the company’s financial health, fostering trust and confidence in the business.

In conclusion, product costing is not merely a financial exercise but a fundamental business practice that guides sound decision-making, cost control, and resource optimization.

It empowers companies to stay competitive, achieve sustainable growth, and navigate the complexities of the market with confidence, all while ensuring the efficient and profitable delivery of products to customers. By investing in robust product costing practices, businesses position themselves for success and create a strong foundation for long-term prosperity.

Want to see Katana in action?

Businesses of all shapes and sizes aim to produce high-quality products that meet customer needs while ensuring profitability. In this quest for success, product costing plays a vital role. It helps determine the cost of goods sold , which eventually determines the price of a product . While there are various types of product costing , we will delve into the four main categories that businesses typically use to categorize their expenses.

Job costing

Job costing is used to calculate the cost of producing a specific product or service. This method takes into account the labor, material, and overhead costs associated with the job. It’s commonly used in industries such as construction, where each project is unique and requires custom pricing.

Process costing

Process costing is used to calculate the cost of producing a large number of identical products. This method is typically used in manufacturing environments where products are made in large batches . The total cost of production is divided by the number of units produced to arrive at the cost per unit.

Activity-based costing

Activity-based costing, or ABC costing, allocates indirect costs to specific products or services based on the activities involved in producing them. This method is useful when many indirect costs are associated with a product, and it’s difficult to determine how to allocate those costs. By identifying the activities involved in producing a product, it becomes easier to determine how much of the indirect costs should be allocated to that product.

Standard costing

Standard costing uses predetermined standard costs for materials, labor, and overhead. The actual costs are then compared to the predetermined costs to identify variances and make adjustments. This method is useful when a company wants to identify areas of inefficiency and reduce costs.

Wondering how to calculate product cost? Finding out the product cost of your business is as simple as applying a quick product cost formula. All you have to do is add up the costs associated with the item’s production and divide them by the total number of units.

The following formula can be used to calculate the product unit cost of your business:

Product unit cost = (Direct labor + direct materials + consumable production supplies + factory overhead) / number of units produced

Product costing examples

Now that you know the formula, let’s take a look at some practical examples of what a product cost analysis looks like:

• A company manufactures 2,000 chairs, and the total cost of producing them is $20,000 . This means that each chair has a product unit cost of $10 ( $20,000/2,000 ).
• A toy manufacturer produces 2,500 toys, and the total cost for materials and labor is $50,000 . Thus, the result is a product unit cost of $20 ( $50,000/2,500 ).

It’s important to include all related costs of manufacturing the product when you calculate product cost. For the chair example, this would include the wood, nails, glue, and labor, among other costs. If these costs exceed the selling price of the chair, then your business is undoubtedly making a loss and needs to re-evaluate the product costing system immediately.

A more intricate way of calculating your costs is known as activity-based costing. It’s a step deeper into understanding your costs. Activity-based costing looks at the activities that go into making a product and assigns costs to those activities rather than the product itself.

For example, let’s say you manufacture computers as your main product. Your activity-based cost analysis might consider the following activities: design, assembly, testing, and shipping. Each of these activities has its own associated cost, which is then added together for an accurate total unit cost for each computer produced.

Nevertheless, every company should at least know their product cost as a bare minimum, as this knowledge alone can be used to make effective pricing decisions. When combined with activity-based costing, product costing can be a powerful tool for running an even more efficient business.

This wasn’t meant to be a pun, but product costs are also accounted for in accounting. They are essentially categorized as inventory on the balance sheet and can be tracked in the inventory account (which is often referred to as a current asset).

The total product costs you have incurred for any given period should be reported on the income statement only when sold. This will give you an accurate view of your cost structure, and it’s also essential information when calculating taxes owed or other financial statements.

Managing the financial aspect of your business can be daunting, but with Katana’s cloud inventory platform , you can say goodbye to the hassle and embrace seamless product cost accounting. The software provides an array of tools that simplify the cost-tracking process and allow you to focus on what really matters — your business.

One of the standout features of Katana is the automated production orders system. From the moment an order is placed, the system tracks all costs associated with each product. This ensures that you have access to real-time cost data, enabling you to make informed decisions about pricing and other financial matters quickly and with ease.

With the inventory management feature, you can monitor your stock levels in real time. At the same time, Katana provides accurate information on how much it will cost to produce or purchase more products if needed. This feature helps you to optimize your inventory levels and improve your cash flow.

Katana’s reporting tools offer insights into your company’s financial performance, giving you a clear picture of where your money is heading and where it should be heading in the future. With this information, you can make data-driven decisions about your product costing and confidently take your business to new heights. Book a demo with Katana today!

Product costing FAQs

Product costing is a system used by businesses to determine the total expenses associated with manufacturing a product, which includes direct costs (like materials and labor) and indirect costs (such as overhead and administrative expenses). This information helps in setting appropriate prices and making informed business decisions.

Product cost can be calculated by summing up all the direct costs (materials, labor) and indirect costs (overhead, administrative expenses) incurred in manufacturing a product.

What are product costing examples?

Examples of product costing include determining the total expenses to produce a smartphone (materials, assembly labor, factory overhead) or calculating the cost of producing a handmade artisanal chair (wood, varnish, craftsman’s labor).

What are the four types of costing?

The four types of costing are

• Job costing — Used for customized products or services
• Process costing — For mass-produced items
• Activity-based costing — Allocating costs based on activities
• Standard costing — Compares actual costs to predetermined standards

How is product costing done?

Product costing involves identifying and accumulating all costs associated with producing a specific product, usually through cost accounting systems, allocation methods, and cost allocation bases to ensure accurate cost calculations.

• Accounting Guide
• 1.1. WIP manufacturing
• 1.2. Inventory accounting
• 1.3. Inventory costing
• 1.4. Costing methods
• 1.5. Job order costing
• 1.6. Process costing
• 1.7. Product costing methods
• 2.1. QuickBooks Online inventory limitations
• 2.2. QuickBooks raw materials inventory woes
• 2.3. QuickBooks Online serial number tracking
• 2.4. QuickBooks bill of materials
• 2.5. QuickBooks inventory scanner
• 2.6. QuickBooks inventory asset
• 3.1. Xero bill of materials (BOM)
• 3.2. Xero raw materials
• 3.3. Xero barcode inventory system
• 3.4. Xero inventory add-ons
• 4. E-commerce accounting
• 5. QuickBooks vs. Xero: which is best?
• 6. Best accounting software for manufacturing

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What is Product Costing? A Comprehensive Guide with example for Business Owners and Managers

Welcome to our comprehensive guide on product and food costing, specifically tailored for restaurant owners and managers. In this blog post, we will delve into the essential components of costing, including labor, materials, and overhead. We will provide practical example of costing a delectable Baked Dijon Salmon. So, let’s dive in and explore the world of product and food costing!

I. Understanding Product Costing

Definition of product costing:.

Product costing refers to the process of determining and allocating the costs associated with producing a specific product or service. It involves analyzing and breaking down the various cost components involved in the production or provision of the product, such as labor, materials, and overhead expenses. By accurately calculating these costs, businesses can make informed decisions regarding pricing, profitability, budgeting, and resource allocation.

The definition of product costing can vary slightly depending on the context. In manufacturing industries, product costing typically focuses on determining the costs associated with producing goods. This includes direct costs, such as raw materials and labor, as well as indirect costs, such as factory overhead, utilities, and depreciation of production equipment. The goal is to calculate the cost per unit of the product, which helps businesses set appropriate prices, evaluate profitability, and make strategic decisions about production volumes and pricing strategies.

In the context of service-based businesses, product costing can also apply to the costs associated with providing a specific service. For example, in the restaurant industry, product costing involves analyzing the costs of ingredients, labor, and overhead expenses required to prepare a menu item. This helps determine the cost of goods sold (COGS) and enables businesses to set menu prices that cover their expenses while remaining competitive.

Accurate product costing provides several benefits for businesses. It helps control costs by identifying areas of inefficiency, reducing waste, and optimizing resource utilization. It allows businesses to make informed pricing decisions based on a thorough understanding of the costs involved. Additionally, product costing aids in financial planning, budgeting, and forecasting, ensuring that businesses have a realistic understanding of their costs and can allocate resources effectively. Ultimately, product costing provides businesses with the necessary insights to improve profitability, make strategic decisions, and maintain a competitive edge in the market.

Key Components:

The key components of product costing are the fundamental elements that make up the total cost of a product or service. These components help businesses understand and analyze the cost structure associated with the production or provision of a specific item. The primary key components of product costing include labor, materials, and overhead expenses. By understanding and calculating these key components, businesses can determine the total cost of a product or service. This information is crucial for setting appropriate prices, evaluating profitability, making informed decisions about resource allocation, and identifying areas where cost optimization measures can be implemented. Analyzing each component individually provides insights into cost drivers and enables businesses to effectively control costs, enhance competitiveness, and maximize profitability.

Labor Costs:

Labor costs refer to the expenses associated with the workforce involved in the production or provision of a product or service. This includes wages, salaries, benefits, and other compensation provided to employees directly involved in the production process. Calculating labor costs involves determining the time spent on various tasks, such as manufacturing, assembly, packaging, or service delivery, and multiplying it by the applicable labor rates.

Materials Costs:

Materials costs encompass the expenses incurred for the raw materials, components, or ingredients required to manufacture or create a product. These costs can include the cost of purchasing or acquiring materials, as well as any transportation or storage expenses associated with them. Calculating materials costs involves considering the quantity and cost of each material used in the production process.

Overhead Expenses:

Overhead expenses, also known as indirect costs, are the expenses incurred in the production process that cannot be directly attributed to a specific product or service. They include costs associated with facility maintenance, utilities, depreciation of machinery, administrative expenses, and other general expenses necessary for the overall operation of the business. Allocating overhead expenses to specific products or services often involves using predetermined allocation methods, such as allocating based on labor hours, machine usage, or square footage.

Importance of Accurate Costing:

Accurate costing is of utmost importance for businesses for several reasons. accurate costing is vital for businesses as it facilitates profitability analysis, informed decision-making, effective budgeting, cost control, pricing strategies, and supplier management. It provides businesses with the necessary insights to optimize costs, maximize profitability, and make strategic decisions that drive long-term success. Let’s explore the key reasons why accurate costing is crucial:

Profitability Analysis:

Accurate costing provides a clear understanding of the costs associated with producing or providing a product or service. By knowing the true costs, businesses can accurately determine the profitability of each product or service offering. This information is essential for making informed pricing decisions and ensuring that prices are set at a level that covers costs and generates a reasonable profit margin.

Informed Decision-Making:

Accurate costing data enables businesses to make informed decisions regarding resource allocation, production planning, and investment. With a thorough understanding of costs, businesses can identify areas for cost optimization, allocate resources effectively, and make strategic decisions that align with their financial goals. This helps businesses avoid unnecessary expenses and maximize their return on investment.

Budgeting and Financial Planning:

Accurate costing is crucial for creating realistic budgets and conducting effective financial planning. By knowing the true costs of production, businesses can set appropriate targets, forecast revenues and expenses accurately, and allocate resources efficiently. This ensures that financial resources are managed effectively and that the business operates within its financial means.

Cost Control and Waste Reduction:

Accurate costing provides businesses with insights into cost drivers and areas of inefficiency. With this knowledge, businesses can implement cost control measures, identify waste and inefficiencies in the production process, and take steps to reduce them. This leads to improved operational efficiency, cost savings, and enhanced profitability.

Pricing Strategy:

Accurate costing information allows businesses to develop effective pricing strategies. By understanding the true costs involved in producing a product or providing a service, businesses can set prices that are competitive in the market while still ensuring profitability. Accurate costing enables businesses to avoid underpricing, which can lead to financial losses, and overpricing, which can result in reduced demand and lost sales opportunities.

Negotiation and Supplier Management:

Accurate costing information is essential when negotiating with suppliers or seeking cost-saving opportunities. It provides businesses with a clear understanding of the costs associated with raw materials or inputs, allowing them to negotiate better terms, identify alternative suppliers, or implement cost-saving measures within the supply chain.  

II. Product Costing Example: Baked Dijon Salmon

Recipe Overview: Presenting the recipe for Baked Dijon Salmon (Serving Size 4) and detailing the required ingredients using Costbucket Inventory Management Software

Ingredients

¼ cup butter, melted

3 tablespoons Dijon mustard

1 ½ tablespoons honey

¼ cup dry bread crumbs

¼ cup finely chopped pecans

4 teaspoons chopped fresh parsley

4 (4 ounce) fillets salmon

salt and pepper to taste

1 lemon, for garnish

Labor Cost Calculation:

Calculating the labor cost involved in preparing the salmon dish requires a breakdown of the time spent on various tasks and applying the appropriate labor rates. Let’s demonstrate the process step-by-step:

Identify the Tasks:

Start by identifying the specific tasks involved in preparing the salmon dish. This may include activities such as prepping the ingredients, cooking the salmon, plating the dish, and cleaning up.

Determine the Time Spent:

Next, estimate the time spent on each task. This can be done by observing the process or consulting with the individuals responsible for performing the tasks. For example, let’s assume the following estimated times for our Baked Dijon Salmon recipe:

Prepping the ingredients: 15 minutes

Cooking the salmon: 20 minutes

Plating the dish: 5 minutes

Cleaning up: 10 minutes

Calculate the Labor Hours:

Convert the estimated times into labor hours. Divide the time spent on each task by 60 to convert it from minutes to hours. Using our example:

Prepping the ingredients: 15 minutes ÷ 60 = 0.25 hours

Cooking the salmon: 20 minutes ÷ 60 = 0.33 hours

Plating the dish: 5 minutes ÷ 60 = 0.08 hours

Cleaning up: 10 minutes ÷ 60 = 0.17 hours

Determine the Labor Rates:

Next, determine the labor rates for the individuals involved in the tasks. This may vary depending on factors such as job roles, experience levels, and local labor laws. Consult your business’s payroll or human resources department for the applicable labor rates. For simplicity, let’s assume a flat labor rate of $15 per hour for all tasks.

Calculate the Labor Cost:

Multiply the labor hours for each task by the corresponding labor rate to calculate the labor cost. Using our example labor rates:

Prepping the ingredients: 0.25 hours × $15/hour = $3.75

Cooking the salmon: 0.33 hours × $15/hour = $4.95

Plating the dish: 0.08 hours × $15/hour = $1.20

Cleaning up: 0.17 hours × $15/hour = $2.55

Sum up the Labor Costs:

Finally, sum up the labor costs for all the tasks to determine the total labor cost involved in preparing the salmon dish. In our example: $3.75 + $4.95 + $1.20 + $2.55 = $12.45 . For a serving size of 4 people, this would be $12.45 divided by 4 = $3.11. Please note that the larger number of servings the lower the labor cost per meal. So for the same prep time, if the serving size is 10 people it would bring the labor cost per meal down to $1.25.

Materials Cost Calculation:

Calculating the materials cost involves breaking down the cost of each ingredient used in the recipe. Here’s a step-by-step process for calculating the materials cost shown in Costbucket:

Identify the Ingredients:

Start by identifying all the ingredients used in the recipe. For the Baked Dijon Salmon, the ingredients include salmon, bread crumbs, pecans, seasonings, and any other components required for the dish.

Determine the Quantity:

Next, determine the quantity of each ingredient required for the recipe. This information can be obtained from the recipe itself or by referring to standard portion sizes. For example, if the recipe calls for 4 units (4 ounce per unit) fillets of salmon, you know you’ll need 4 units of salmon.

Obtain Ingredient Prices:

To accurately calculate the materials cost, you need reliable sourcing information for ingredient prices. This can be obtained from suppliers, grocery stores, or online marketplaces. It’s important to ensure that the prices you use are up to date and reflect the quality and quantity of the ingredients required.

Calculate the Cost per Unit:

For each ingredient, multiply the quantity required by the unit price to calculate the cost per unit. For example, if a pound (16 ounces) fillet of salmon costs $10.99 and you need 4 fillets, the cost per unit of salmon would be $5 × 4 = $20.

Determine Total Material Costs:

Continue this process for each ingredient and calculate the cost per unit for each one. Then, sum up the costs of all the ingredients to determine the total material cost. For instance, if the bread crumbs cost $2, pecans cost $3, and the seasonings cost $1, the total material cost would be $20 (salmon) + $2 (bread crumbs) + $3 (pecans) + $1 (seasonings) = $26.

It’s important to note that the accuracy of the materials cost calculation depends on obtaining reliable sourcing information for ingredient prices. Consider factors such as seasonality, market fluctuations, and bulk purchasing discounts when determining ingredient costs.

By following these steps and using accurate ingredient pricing, you can calculate the materials cost for the Baked Dijon Salmon recipe. This information is valuable for understanding the direct cost of the ingredients and pricing the dish appropriately to cover expenses and ensure profitability.

Overhead Cost Calculation:

Calculating overhead costs involves allocating indirect expenses to the salmon dish. These expenses include costs such as electricity, water, kitchen supplies, and other overhead expenses incurred during the production process. Here’s a step-by-step process for allocating overhead costs:

Identify Overhead Expenses: Start by identifying the overhead expenses associated with the production process of the salmon dish. This may include electricity used for cooking, lighting, and equipment operation, water consumed during cooking and cleaning, kitchen supplies like utensils and cookware, and any other indirect expenses specific to your business.

Determine Allocation Basis: Next, determine an appropriate allocation basis to allocate the overhead expenses to the salmon dish. Common allocation bases include labor hours, machine usage, square footage, or a specific percentage of total overhead costs. Choose an allocation basis that reflects the usage or consumption of resources by the salmon dish.

Calculate Overhead Rate: To calculate the overhead rate, divide the total overhead expenses by the chosen allocation basis. For example, if the total overhead expenses for a month are $2,000 and the allocation basis is labor hours, with a total of 400 labor hours in that month, the overhead rate would be $2,000 / 400 = $5 per labor hour.

Determine Allocation for the Salmon Dish: Based on the allocation basis chosen, determine the usage or consumption of resources by the salmon dish. For instance, if the salmon dish takes 1 hour to prepare and the overhead rate is $5 per labor hour, the overhead allocation for the salmon dish would be $5.

Repeat for Other Overhead Expenses: Repeat the process for each overhead expense. Determine the appropriate allocation basis for each expense and calculate the allocation accordingly. For example, if kitchen supplies cost $100 for the month and the allocation basis is the number of salmon dishes produced (e.g., 10 dishes), the overhead allocation for kitchen supplies would be $100 / 10 = $10 per dish.

Sum up the Overhead Allocations: Finally, sum up the overhead allocations for all the expenses to determine the total overhead cost allocated to the salmon dish. In our example, if the overhead allocation for electricity is $5 and for kitchen supplies is $10, the total overhead cost allocated to the salmon dish would be $5 + $10 = $15.

By following these steps, you can allocate the overhead costs, such as electricity, water, and kitchen supplies, to the salmon dish. This helps in accurately determining the total cost of the dish, considering both direct and indirect expenses and aids in setting appropriate prices and evaluating profitability.

Total Cost Calculation:

Calculating the total cost per serving of Baked Dijon Salmon involves summing up the labor, materials, and overhead costs. Let’s break down the process step-by-step:

Calculate Direct Labor Cost : Using the labor cost calculation method discussed earlier, determine the labor cost involved in preparing the Baked Dijon Salmon dish. For example, if the labor cost is $12.45 per preparation (as calculated previously), this cost remains constant regardless of the number of servings.

Calculate Direct Materials Cost: Using the materials cost calculation method discussed earlier, determine the cost of ingredients for the Baked Dijon Salmon recipe. Let’s assume the materials cost is $26 for the entire recipe.

Calculate Overhead Costs : Using the overhead cost calculation method discussed earlier, determine the overhead cost allocated to the Baked Dijon Salmon dish. For example, if the overhead cost is $15 per dish (as calculated previously), this cost remains constant per serving.

Sum Up the Costs : To determine the total cost per serving, add up the labor cost, materials cost, and overhead cost. Using the values from the previous calculations: Total Cost per Serving = Labor Cost per Preparation + Materials Cost / Number of Servings + Overhead Cost per Dish

Let’s assume the recipe serves 4 people: Total Cost per Serving = $12.45 + ($26 / 4) + $15 Total Cost per Serving = $12.45 + $6.50 + $15 Total Cost per Serving = $33.95

Therefore, the total cost per serving of Baked Dijon Salmon is $33.95.

Calculating the total cost per serving allows you to understand the direct and indirect costs associated with the dish. This information is vital for pricing decisions, profitability analysis, and determining the overall financial performance of the recipe.

Pricing Considerations:

Setting an appropriate selling price for the Baked Dijon Salmon dish requires considering various factors, including the calculated cost, market demand, competition, perceived value, and profit margin goals. Here are some key pricing considerations:

Cost Markup and selling price:

Consider applying a cost markup to the total cost per serving to ensure you cover your expenses and generate a reasonable profit margin. The markup percentage depends on your business’s financial goals, industry standards, and market conditions. For example, if you want to achieve a 30% profit margin, you would add 30% of the total cost per serving to arrive at the selling price.

Market Analysis:

Analyze the market demand and competition for similar dishes. Research the prices of comparable salmon dishes in your area or the industry to understand the price range customers are willing to pay. This information helps you position your dish competitively and avoid overpricing or underpricing.

Perceived Value:

Consider the perceived value of your Baked Dijon Salmon dish. Factors such as the quality of ingredients, unique flavors, presentation, and overall dining experience contribute to the perceived value. If customers perceive your dish as high-quality and worth the price, you may be able to set a slightly higher price.

Menu Strategy:

Take into account your overall menu strategy and pricing structure. Consider the profitability and popularity of other menu items. If the Baked Dijon Salmon is a signature dish or a customer favorite, you might price it slightly higher compared to other menu items to reflect its special status and unique ingredients.

Pricing Psychology:

Understand pricing psychology techniques to influence customer perceptions. For example, using $X.99 instead of rounding up to the nearest whole dollar can create the perception of a lower price. Experiment with different pricing strategies to determine what resonates best with your target market.

Evaluate the impact of the calculated cost and pricing on your profitability. Consider the volume of sales you expect for the Baked Dijon Salmon dish and calculate the projected revenue based on the selling price. Ensure that the projected revenue, when subtracting the costs, yields a desirable profit margin.

Flexibility and Adjustments:

Be prepared to adjust the pricing if necessary. Monitor customer feedback, sales data, and overall market conditions. If the dish is not selling as expected or there are significant cost fluctuations, you may need to revisit and adjust the pricing accordingly.

It’s important to strike a balance between covering costs, meeting profit goals, and appealing to your target market’s price sensitivity. Regularly review and analyze your pricing strategy to ensure it remains competitive, profitable, and aligned with your business objectives.

III. Benefits and Value-Add of Product Costing for Businesses

Cost control and profitability:.

Accurate product costing enables businesses to have better control over costs, identify cost-saving opportunities, and improve overall profitability. By understanding the individual cost components, such as labor and materials, businesses can make informed decisions to optimize expenses and maximize profit margins.

Informed Pricing Decisions:

Product costing provides businesses with valuable insights into the true cost of their products. Armed with this information, they can set appropriate prices that cover their expenses while remaining competitive in the market. Precise pricing helps businesses avoid underpricing, ensuring they generate adequate revenue to sustain operations and invest in growth.

A thorough understanding of product costs allows businesses to create realistic budgets and develop accurate financial projections. With a clear picture of their costs, they can allocate resources effectively, make informed investment decisions, and plan for future growth and expansion.

Performance Evaluation:

Product costing provides a basis for evaluating the performance of products and identifying areas for improvement. By comparing actual costs with expected costs, businesses can pinpoint inefficiencies, streamline operations, and enhance overall productivity.

Inventory Management:

Accurate product costing is vital for effective inventory management. It helps businesses determine optimal inventory levels, reduce waste and spoilage, and prevent overstocking or understocking of products. By aligning inventory levels with demand and cost considerations, businesses can improve cash flow and minimize holding costs.

Competitive Advantage:

Properly understanding and managing product costs gives businesses a competitive edge in the marketplace. They can offer competitive pricing, maintain profitability, and build a reputation for delivering value to customers. Additionally, cost transparency enables businesses to respond swiftly to market changes and adjust their pricing strategies accordingly.

Strategic Decision-Making:

With reliable product costing data, businesses can make strategic decisions regarding product mix, production processes, sourcing options, and resource allocation. This empowers them to adapt to changing market dynamics, identify growth opportunities, and optimize their operations for long-term success.

Frequently Asked Questions

How to track menu pricing effect on sales.

Successful restaurants track their menu prices and sells and continuously adjust their prices when prices fluctuate. Johnny’s price of the Johnny Burger has risen from 14.40 to 14.40. Price rises also have a negative impact on food sales elsewhere.

What to do before you start food costing?

Budget planning plays an important role in running a business. The process is not just a part of a business plan, but a process to keep restaurants profitable and restaurant food cost-efficient. Reviewing your budget regularly can be helpful in determining how your money is spent and in making decisions to improve it. Although some people are worried about numbers they do not need. Monitoring your cash flow and managing your restaurant’s budget is easy to accomplish and will ensure that all of this is happening at hand.

How to calculate food cost percentage?

Food costs percentage consists of dividing the price of goods sold and the profit/sale generated by these products. The costs in goods sold total food sales are the amount of money a customer has spent to purchase ingredients and inventory over a period. We can help with this calculation. If a particular product makes profit, it can make sense based upon its profitability. But you need information to make sure that everything you do in your business succeeds. Take a glance at your daily inventory. 3. List all the items that have arrived in your mailbox for the first time in a month.

Why is food cost percentage important?

For real-time knowledge of restaurant operations, a person should know the percentages of the food cost. A grasp of food costs helps you make decisions about dish prices, dish rentability, and overall cost. The more you understand what your restaurant food costs and prices are, the more equipped you are to choose your menu.

How are product costs related to production costs?

Production costs refer to the cost of materials, labor, or overhead. Cost relates to the purchase of or the production of products for sale. Product costs cover all direct costs for the production of the products. Product prices may be fixed or variable according to the products made. The fixed expenses are constant regardless of quantity and the variable charges are variable. There’s a close link between product cost and manufacturing cost because of the direct impact of manufacturing overhead costs because of product expense.

Should product cost influence product price?

Yes, product costs will affect product prices as compared to other products in the market. The prices of products are usually based on the costs of the item, and market demand, competition, and other factors are also important to determine the prices. A company with lowered prices may be forced to cut costs or lose their business altogether. A firm that raises the price too high might lose revenue to competitors or fail to meet the demand. The price of a business should be determined by examining its product costs. Upon determination of food cost control the total cost to produce the product, the company must also calculate the margin of the product to determine the final price.

What is the difference between actual food cost percentage and ideal food cost?

Actual food cost percentage refers to the actual cost of ingredients and materials used in a dish, divided by the selling price, expressed as a percentage. It helps determine the profitability of a menu item.

Ideal food cost, on the other hand, is the target percentage that businesses aim to achieve for food costs, considering factors like pricing strategies, profit margins, and industry benchmarks. It represents the optimal cost structure that maximizes profits while maintaining quality.

How can I maximize profits through effective cost management?

Effective cost management involves closely monitoring and controlling labor, materials, and overhead expenses. By accurately calculating and tracking these costs, you can identify areas for improvement, optimize pricing strategies, minimize waste, and make informed decisions to maximize profitability.

Can product costs be affected by the manufacturing process?

Yes, the manufacturing process can have a direct impact on product costs. Factors such as production efficiency, equipment utilization, waste reduction, and quality control measures can influence the labor and materials costs associated with manufacturing a product.

What is product unit cost?

Product unit cost refers to the cost incurred to produce or acquire a single unit of a product. It includes the costs of labor, materials, and overhead allocated to each unit. Understanding the product unit cost is essential for pricing decisions and determining the profitability of individual products.

What is the difference between product costs and period costs?

Product costs are the costs directly associated with manufacturing or acquiring a product. They include the cost of labor, materials, and overhead. Product costs are typically incurred in the production process and are considered part of the cost of goods sold.

Period costs, on the other hand, are not directly related to the production process. They are incurred over a specific period and are usually associated with administrative, selling, and general operating expenses.

How can I set competitive prices while considering costs?

Setting competitive prices requires considering both your costs and the market demand. By accurately calculating your costs, including labor, materials, and overhead, you can determine your desired profit margins. Market research and analysis of competitors’ pricing can then help you position your offerings competitively while ensuring profitability.

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What is product cost and how to calculate (with example)

Whether it’s a one-off product or a SaaS subscription, understanding product cost is crucial for any business to succeed. Breaking down your costs into materials, labor, overhead, and other expenses reveals insights into where your money is going.

In this guide, we’ll show you how to calculate product cost and how doing so can help you make informed decisions about crowdfunding, refine your pricing strategy, and improve profitability.

What is product cost?

Product cost refers to the total expenses incurred during the development, production, and maintenance of a software product or technology solution. It encompasses a wide range of costs, including research, design, development, testing, deployment, and ongoing support and maintenance.

Product cost plays a crucial role in determining the pricing strategy and overall profitability of a product or service.

Product cost vs. period cost

While product costs are directly tied to the creation and development of a software product or technology solution. Period costs are the expenses that a company incurs during a specific accounting period but aren’t directly related to the product’s development.

Product costs include direct materials, direct labor, and overhead expenses. These costs are capitalized as inventory and become part of the cost of goods sold when the product is sold.

Period costs, on the other hand, are typically associated with selling, general, and administrative (SG&A) expenses, such as marketing, rent, salaries for non-production staff, and other administrative costs. Period costs are expensed in the period they are incurred and appear on the income statement as operating expenses.

Understanding how to properly categorize these costs helps you optimize your spending, prioritize investments, and ultimately, drive the company’s growth and success.

Why product cost is important for product managers

Put simply, understanding the costs of developing a product, feature, or update helps you make more informed decisions throughout the product lifecycle.

But it’s not just about knowing the costs. It’s also about knowing the value a project will bring to the product. This not only helps you determine the next project to prioritize but also maximizes your profits.

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When it comes to pricing, many stakeholders have a say in how much a customer should pay for a product. It should be a collaborative effort from executives, marketing, sales, product managers, and finance. Depending on the company, product managers may or may not determine the pricing strategy for the product. Either way, you should at least participate in the conversation.

How to calculate product cost

Calculating product costs can be a difficult task, especially when it comes to determining the development costs of SaaS. However, there are some basic formulas to help calculate the product cost.

But first, let’s go over the few variables that affect product costs. These include:

• Direct material — Raw materials that are easily measurable and used to directly manufacture products
• Direct labor — Wages, payroll taxes, benefits, and insurance of employees who directly work on the product
• Indirect material — Materials used in the manufacturing process but aren’t classified as direct material. Examples include office supplies
• Indirect labor — Wages, payroll taxes, benefits, and insurance of employees who aren’t directly manufacturing the product, but are crucial for a smooth manufacturing process. One example is managerial roles
• Other overhead — Overhead costs that aren’t classified as material or labor but are part of the overall expenses. An example is the electricity bill

To calculate product costs, you’ll use the following equation:

Direct labor + direct material + overhead = Product costs

To break this down into a per-unit cost, then use this formula:

Product costs (the answer from the previous equation) divided by the number of units produced = Per-unit cost

Let’s apply this formula using a practical example. Suppose you’re developing a new mobile application. The following costs are associated with the development of the app:

• Direct material — $5,000 (licensing fees for software libraries)
• Direct labor — $50,000 (salary and benefits for developers)
• Overhead — $20,000

Using the formula, we can calculate the product cost as follows:

$5,000 (direct material) + $50,000 (direct labor) + $20,000 (overhead) = $75,000 (product costs)

Now, let’s say the company expects to develop and sell 500 units (subscriptions) of the mobile application. To determine the per-unit cost, we’ll use the following formula:

$75,000 (product costs) / 500 (number of units produced) = $150 (per-unit cost)

With this information, you can make informed decisions about pricing strategies, potential profitability, and areas to optimize costs during the development process.

Factors that affect product cost

Various factors can influence the overall cost of developing and maintaining a software product or technology solution. By understanding these factors, product managers can better manage their resources, anticipate potential challenges, and make informed decisions that ultimately impact the product’s success. The following are some key factors to consider when evaluating product cost:

Scope of product

Developer costs, team structure, equipment and software purchases, other costs.

You may be envisioning a SaaS product with several features and components. It can be costly to fully build out this level of complex software and maintain it. You’ll also need to consider quality assurance processes and maintenance.

An excellent developer usually also comes at a high costs. However, it may pay off in the long run if they deliver high-quality code. Some cost-saving measures, like hiring junior developers, may result in several issues later on in the development process.

Are you going to hire employees, an agency, or freelancers to build your product? Each option has varying costs.

For example, an in-house employee will expect benefits like paid time off, workspaces, and equipment. Meanwhile, a freelancer wouldn’t expect any of those benefits. In some cases, this is a more affordable option.

You may need to buy state-of-the-art equipment for your developers and other team members. You may also face development expenses such as external APIs. These are variables that can impact your product costs.

It’s not enough to just build a great product. You also need to invest in marketing, sales, customer support, legal, and more to ensure your product reaches the hands of the customers you want to serve.

A bit harder to calculate, time is a crucial factor to consider nevertheless. The software development lifecycle is time-consuming, and you may face obstacles that could lengthen your timeline.

Time is money in this scenario, so you’ll want to consider how long you expect the development process to take and keep track of the actual timeline of events.

Strategies to reduce product cost

You may find yourself in a situation where you determine your production costs are more than you desire. Or, maybe your customers aren’t willing to pay that much for your product. In this case, you may want to consider strategies to reduce product costs.

But reducing product costs can come with an unexpected price that doesn’t involve money: if you’re not careful, it could end up lowering the quality of the product. It’s a delicate balancing act to minimize product costs without compromising on quality.

Here are some strategies to consider if you want to reduce your product cost without dropping your standards:

Do your customer research correctly

Create a minimal viable product (mvp), analyze your current tech, understand the scope of the project, don’t skimp on quality assurance.

Customer research may be the most important step in building and maintaining any product. Many product managers and stakeholders think they know what the customer wants . Sometimes they’re right, but when they’re wrong, the consequences could be disastrous.

Backing up your assumptions with data can bolster your confidence that you are building a product that actually meets the needs of your customers. Alternatively, customer research can show that you are on the wrong path and need to pivot. This is an essential step, and it shouldn’t be skipped over.

A minimal viable product (MVP) is an app or product that is just functional enough to serve early adopters’ bare-minimum needs.

By aiming to create a useful product with minimal features, you can avoid spending too much time and money on features that may or may not resonate with your target market.

Your tech stack can have an impact on your budget. For example, you may be using several SaaS applications that have overlapping features. You may also be maintaining your own servers, but using cloud servers could help lower costs.

Evaluating your expenses can help you determine whether you’re getting the most value out of them or need to consider alternatives.

Before you even begin developing a product, you need a clear plan for what you’re building. Without a project plan or product roadmap , it’s hard to make sure all stakeholders and teams are on the same page.

You’ll need to have the following to reduce labor and costs:

• Technical specifications
• Wireframes or a design vision
• Detailed development plan

This may seem like an additional cost at first, but quality assurance (QA) is crucial to spotting errors and bugs. Without QA, your development costs could increase and your timeline can extend further than originally anticipated.

An investment in QA can go a long way toward protecting your budget and preventing your project from becoming overdue.

Knowing the true costs of development can help you determine what features to build, whether for an MVP or for your next major update.

With a solid financial plan in place, you can identify which components are driving up your product costs and adjust accordingly. This way, you can optimize your resources and maximize profits.

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Costing Methods: A Complete Guide

Every company has a unique nature and set of traits. It must thus use a variety of costing methods to determine the price of its items. For any manufacturer, choosing the appropriate price for a product is crucial.

If you overcharge for your product, you risk losing potential clients to your rivals. However, if you underprice the item, your accountant can get nervous when they see the balance sheet. There are numerous costs methods that organizations can use to increase their profit margin .

You may provide the best value for both yourself and your customers while relieving your accountant's burden by using the costing method that is most appropriate for your firm.

With this approach, you begin with the sale price in mind since you already know what it should be. In this post, we'll look at the concept of costing methods and the several types of costing you might employ to keep tabs on expenses in your business. Following are the topics covered:

What Is Costing?

Methods of costing, what is the importance of the costing method, what costing method should manufacturers choose, how to calculate overheads, key takeaways.

A system for determining out a company's cost of production is called costing, or cost accounting. This method of accounting examines both variable and fixed costs incurred over the course of manufacturing. Costing data is used by businesses to verify that every aspect of production is profitable and effective.

Contrary to other types of accounting, costing operations are carried out by an organization's internal management. This internal management is not visible to clients or institutions from the outside.

Cost accounting has more latitude than other types of accounting because there are no rigid requirements it must follow.

What Is a Costing Method?

A costing method is a way for figuring out how much something will cost. In order to assign a cost to a manufactured good, product costing techniques are used.

The cost of producing a good or providing a service is simply the sum of all the costs associated with that good or service. Each of these approaches can be used in various production and decision-making situations.

Be careful to use the information just for its intended purpose. For instance, a costing method designed for incremental pricing decisions may not be acceptable for long-term decision making. The type of costing method employed can lead to significant variances in costs.

Short-Term vs Long-Term Pricing Decisions

Manufacturers will prioritize direct costs, or expenses directly related to manufacturing. They will make short-term pricing decisions. In contrast, businesses must take indirect expenses and/or overhead costs into account when making long-term pricing and profitability decisions.

In general, the term " manufacturing overhead " is used to describe indirect expenditures that originate from manufacturing processes (such as plant maintenance, rent, etc.).

Administrative overhead is the term used to describe indirect expenditures that are connected to non-manufacturing operations (such as office supplies, G&A wages, telephone, rent, heat, admin related depreciation , etc.).

To ensure the long-term viability of a company, it is crucial to comprehend how these factors affect pricing. This is crucial when analyzing long-term pricing.

Types of Costing

Marginal Costing: Only the variable costs, such as direct materials, direct expenses, direct labor, and variable overheads, are allotted to production using this method. The variable overheads are allotted to production using this method.

• The fixed cost of production is not included. Costs are classified as constant or variable under marginal costing.
• Variable costs often vary in a directly proportionate manner based on changes in the volume of output. Fixed costs typically remain stable or constant.
• Dealing with the effects of changes in output volume or range on a company concern's costs or profit is the major goal of marginal costing.
• Divide the variation in production costs by the variation in quantity to determine marginal cost.
• Finding the point at which an organization can realize economies of scale to improve production and overall operations is the goal of marginal cost analysis.
• The manufacturer may make money if the marginal cost of producing one extra unit is less than the price per unit.

Standard Costing: Standard costing refers to the process of predetermining costs based on preset standards. This is done under specific operating conditions. Historical costing is the process of determining and recording costs after they have been incurred. It acts as a postmortem of the actual expenditures and gives the management a record of what actually occurred.

This method is referred to as conventional costing or actual costing because it is conventional. There are two methods for determining actual costs: post costing and continuous costing.

Historical Costing: You register a company asset at its purchase price using the cost principle. Keep track of assets on the balance sheet at the cash value they had at the time of purchase.

The price of an asset is not altered to reflect market fluctuations. Liabilities can be recorded using the historical cost concept as well. It doesn't matter how small your business is; your assets are important.  You must be able to effectively manage and account for them.

• Asset tracking may be done easily and accurately using the cost principle.
• The historical cost principle ensures that an objective cost was documented by displaying the real price you paid for an asset.
• The price tenet is based on previous exchanges. The cost principle may not always be the best method for determining an asset's worth.
• The price principle may not accurately reflect the value of some goods.
• You might need to consider an asset's fair market value if its market is one that fluctuates regularly.
• With long-term assets, historical cost accounting is typically more challenging.
• Long-term assets are valuable possessions that you do not anticipate selling for cash in the near future. Long-term assets include things like buildings, land, cars, and other machinery.
• When selling long-term assets, the cost principle might be challenging to understand. Between the time you made the initial purchase and the time you sell the item, the market value may have altered.
• It may be more difficult to assess the financial health of your firm due to the diverse values. The various values in your financial statements must be explained.

Long-term assets typically lose value over time. After so many years, the cost principle might no longer accurately reflect the current worth of long-term property. A building's value today could be different from what it was fifty years ago, for instance.

On the other side, you don't own short-term assets for a long enough period of time for their value to drastically fluctuate. The value of short-term assets like inventory shouldn't be significantly impacted by market value.

Absorption Costing: The method of absorbing production's fixed and variable costs is called absorption costing . This method involves adding all costs, including fixed and variable costs , to the production.

Absorption costing is described as "the practice of charging all expenses, whether variable and fixed, to operations, processes, or products". It is a practice of the Institute of Cost and Management Accountants.

There is no distinction between fixed costs and variable costs when using absorption costing. To calculate the cost of production, both fixed and variable costs are taken into account. Full costing is another name for absorption costing.

Uniform Costing: The adoption of the same costing principles and procedures by many undertakings is known as uniform costing.

In order to provide cost data that are as comparable as possible, it is a strategy or method of costing. Several firms within a field or industry use a similar costing system. Through mutual comparison, standard costs can be established and cost management is secured in the company.

It is also possible to advise appropriate actions to regulate and lower costs. Uniform costing aims to standardize accounting practices and provide assistance in establishing reasonable prices for the goods produced by businesses that use this approach.

Thus, the objectives of a uniform costing system are:

• It guarantees that the product prices are established using accurate costing information.
• It offers trustworthy data for comparing cost performances amongst units.
• It offers information to compare the production costs and efficiencies of various companies.
• It is beneficial to determine the industry's overall cost of production on a basis that all individual units or firms may accept.

Uniform costing is not a separate or different method of cost accounting. Only members of the industry or trade association may use this technique of cost accounting. The industry members adopt the same costing ideas, processes, and procedures in order to compare firms.

Lean costing: Lean accounting, also known as lean costing, aids in improving an organization's financial management procedures. Instead of using conventional or traditional historical costing methods, lean costing assigns value-based pricing to the expenses of production. Lean costing is a method of estimating the costs of production.

Based on lean performance measures, this gives the organization an idea of where waste may be reduced. This is done to maximize efficiency in the production process.

Categories of Business Expenses

Variable Cost: A variable cost is a type of business expense whose amount varies according to how much a company produces or sells. Depending on a company's production or sales volume, variable costs grow or fall. They increase with rising production and decline with falling production.

A manufacturing company's raw material and packaging costs, or a retail business' credit card transaction fees or shipping costs, which increase or decrease with sales, are examples of variable costs. A fixed cost and a variable cost can be compared.

Fixed cost: Fixed costs are expenses that would not change regardless of changes in output. They would still be incurred even if no output were produced. For instance, rent, interest charges, real estate taxes, and employee wages.

However, fixed costs are limited to a set time period because they can fluctuate over the long term. A manufacturer, for instance, can opt to raise capacity in response to the rise in demand for its product. This necessitates a larger level of investment in plant and equipment.

Total Cost: Total cost is determined by adding up fixed, variable, and semi-variable expenses. It is often expressed as the sum of all costs that are both fixed (such as the cost of a building lease and the cost of large machinery) and variable (such as the cost of labor and raw materials), which change depending on the level of output.

Long-term rate of increase in variable costs with increasing output will be progressively greater if fixed costs are not changed. For example, by purchasing a larger building or more heavy gear.

This is because extra units of output have diminishing returns. Or, to put it another way, over time, increasing inputs of variable costs will result in progressively fewer units of output.

Direct and Indirect cost : Costs incurred directly include labor used to produce the items. The cost of the items is also reflected in the main materials used in their manufacture. Prime expenses and direct costs are both used interchangeably.

The costs associated with the entire plant, such as those brought on by the usage of energy and fixed assets, fall under indirect costs. Overhead is another name for indirect expenditures.

Indirect Costs in Manufacturing

The common misconception regarding production costs is that they only include direct expenses like labor and raw materials. New manufacturers frequently overlook indirect expenses. These must be considered when determining product prices.

The various expenses required to keep your firm operating that aren't directly tied to the production process are known as indirect costs. These may incorporate:

• Utilities such as electricity, water, and gas
• Mortgage or rent payments
• Marketing and advertising expenses
• Equipment upkeep and repairs
• Administrative expenditures such as payroll and accounting

You can see your manufacturing costs more clearly after calculating indirect costs. But doing so can be difficult and time-consuming. The advantages of accuracy must be weighed against the expense of devoting a lot of time and resources to this task.

It could not be worth the expense, for instance, if one technique of figuring out your costs is 7% more accurate than the other. It would take your cost accountants ten times longer to complete.

Incremental cost: This is mostly the incremental expense incurred while producing one more unit of production. Additionally known as differential cost. Managers in businesses are considerably more concerned with the additional costs associated with producing a product than they are with the allocated cost of overhead.

They just care about the expenditures that are incurred when one more unit is generated. They only want to make sure that a profit margin is being made with each incremental product sale.

This category's primary product costing techniques include:

• Direct costing: This is an accounting of all expenses that are directly related to the manufacture and sale of a good. These expenses include direct materials, piece-rate labor, and commissions. The cost that results can be used to determine the lowest price that a product can be sold for and still make a profit.
• Throughput costing: This analysis examines the effects that one extra unit flowing through the bottleneck operation will have on the business's overall throughput (revenue minus entirely variable costs). The throughput produced per minute of manufacturing time at the bottleneck operation is the main focus of product costing.

Opportunity Cost: It is described as the price of giving up an alternative (benefit, profit, or value) in order to take a specific course of action. The value or advantage forfeited by engaging in a specific activity in comparison to engaging in an alternative activity is known as the opportunity cost of that activity.

Simply put, it means that if you choose one activity, you forfeit the chance to do another. The difference between the anticipated returns of each alternative is all that needs to be considered when estimating an opportunity cost.

Sunk Cost: An investment that has already been made but cannot be recovered is referred to as a sunk cost, also known as a retrospective cost. Sunk costs in company include things like marketing, research, installing new software or equipment, and paying for workers and benefits. Sunk also pays for facilities.

Inventory Costing

Companies assign costs to products during inventory costing. This is also known as inventory cost accounting. Incidental expenses like storage, administration, and market fluctuations are also included in these expenditures. In order to prevent corporations from overstating these costs, generally accepted accounting standards (GAAP) adopt standardized accounting guidelines.

Inventory costing is a component of inventory management. A supply chain's proper inventory management lowers overall inventory costs and aids in deciding how much of a product a company should hold. All of this data aids businesses in determining the necessary margins to allocate to each product or product category.

Materials that have been purchased and materials that are Made-to-Stock (MTS) are priced based on inventory costs. The majority of businesses will use one of the following inventory costing methodologies:

• First-In, First-Out (FIFO)
• Last-In, First-Out (LIFO)
• Average or Weighted Average Cost
• Specific Identification

These costing approaches specify how inventory is valued and costed each time it is added to a pool of inventory. When inventory items are sold or used in production, the cost of the sale or WIP (Work In Progress) assigned to the transaction is calculated by multiplying the quantity of inventory items from one inventory layer by the inventory layer's unit price in order to meet the needs of the sale or manufacturing.

Each approach establishes the cost of the inventory that is allocated to Cost of Goods Sold (CGS)/Work in Progress (WIP).

FIFO: The oldest layers of inventory are used first (based on the date of receipt or the date of manufacture), according to FIFO. The majority of businesses use this technique because it typically provides a better connection of the material costs related to a sale. The cost of a sale is typically lower than the material costs related to a sale.

LIFO: According to LIFO, the newest layers of inventory are those based on the date they were manufactured or received. The newest layers are depleted before the oldest layers. Few manufacturers use this technique. Additionally, it can no longer be used in industries where manufacturers file their financial statements in line with IFRS.

• When the price of a manufacturer's most recent inventory is mixed together with current inventory and neither is obvious. It does offer some validity, though.
• As an example, consider a coal mining corporation that transports inventory from various mines to a single storage pit.
• Regardless of the mine from which it originated, each load from each truck arrival is stacked one on top of the other. When the business makes a sale, they use the coal from the "top" of the pit (i.e. newest coal first – or last in, first out).
• Since the top (newer) layers of coal in this scenario will be sold before the older layers, LIFO would be a more realistic costing analysis.

Average or Weighted Average: In essence, the average or weighted average proves that there is only one inventory layer in the stock. The "average cost" of all the things that are currently available in the inventory pool makes up that tier.

A new "per unit output price" is calculated each time an additional layer of inventory is added. It is then applied to every outbound inventory transaction until the next time the item is bought and received into inventory. A new "outbound unit price" will then need to be calculated.

Specific Identification: Each inventory item is given a specific cost according to the concept of specific identification. When an item is sold or used in production, its specific cost is appropriately assigned as COGS or WIP.

Even if you are purchasing a group of the same thing, each item in the group bears a specific cost that should not be allocated (shared) throughout the group, this practice makes sense if you are purchasing pricey, separately purchased items.

Keeping this level of particular cost detail in inventory is unnecessary. There aren't any items with high price tags or distinctive cost structures.

Production Costing

There are several different production costing techniques available. Each has advantages and disadvantages of its own. All of the direct and indirect costs firms incur when producing a good or rendering a service are referred to as production costs.

Various expenditures, including labor, raw materials, consumable manufacturing supplies, and general overhead, might be included in production costs. The following are the main production costing techniques used:

• Product Costing- Job Costing, Process Costing

Standard Costing

Multiple Costing

• ABC Costing

Unit Costing

Direct Costing

Batch Costing

Operation Costing

Target Costing

Product Costing

The process of calculating the costs associated with producing a specific product is called product costing. The consumption of components and raw materials, labor costs, and overhead expenses specific to one unit are included in this overall cost.

Product costing is crucial for accountants in order to value inventory and determine the cost of products sold. However, managers start with product costing when determining which things to produce and how much to charge for those that are.

You can use a variety of pricing techniques to get the product's ideal selling price after computing the cost per unit. A manufacturing performance statistic that aids in monitoring production costs is the cost per unit.

The following are the primary techniques for determining product costs:

Job Costing: This approach determines expenses for each work order independently. Because they each have their own specifications and scope. This kind of costing also applies to custom-made goods.

To manufacture an item(s) for sale, MTS to be sold later, or to be used in future production. Job costing (variable costing) includes taking materials, labor, and overhead and adding them to a production process. Costs are accrued through transactions that take place for:

• The amount of manufacturing and office expenses allocated to the product being produced
• Stock purchases and WIP inventory assignments
• Specialized work charged at employee rates

Production settings that use Make-To-Order (MTO) are the main users of this sort of costing. Job costing has the benefit of enabling manufacturers to track the exact costs associated with producing one or more items. It also enables manufacturers to add a markup to achieve the targeted profit margin for the product.

• If a factory has good control over their variable and overhead costs, it may produce very accurate quoting and pricing in this context. Direct expenses are directly related to a product.
• One drawback of job costing is that it typically leads to a lot of transaction level activity that is needed to track all the various charges that are continuously assigned to the manufacturing process. This is in order to arrive at correct costing for a product.
• Not to mention, managing and updating manufacturing costs appropriately requires quite complex software systems. Additionally, it may be difficult to absorb overhead into productive activities.

If you are an MTO manufacturer, it is crucial for your environment to be able to track real-time costs per unit of production as well as the ability to establish/manipulate overhead absorption as frequently as necessary without a lot of manual intervention, especially if you hope to accurately price products as they are being produced.

Example: Repair of buildings, Painting etc.

Contract costing: Terminal costing is another name for it. In essence, this approach is comparable to job costing. It is utilised, nonetheless, when a large and lengthy task is involved. The task is completed in accordance with the client's requirements.

Finding out the costs expended on each contract separately is the goal of contract costing. As a result, each contract has its own account. Companies that build ships, buildings, bridges, dams, and roads employ this technique.

Process Costing

It is applied to goods that go through various processes. The production of cloth involves several steps, including spinning, weaving, and the final result. Each process produces an output that may be marketed as a finished good in and of itself. Process costing is therefore used to determine the price of each production stage.

• Process costing is a crucial product costing technique for manufacturing firms. It is used for firms that mass produce numerous identical goods or output units.
• Many businesses, including those that produce food, chemicals, textiles, glass, cement, and paint. Many of these businesses employ process costing extensively.
• When employing process costing, businesses track the costs associated with each step of the manufacturing process. They divide the sum by the number of items produced to arrive at the item cost.
• Businesses can determine costs in a variety of ways. These include first in, first out (FIFO), standard costing, and weighted average costing.

In the oil, chemical, lumber, textile, and food processing industries, process costing is especially crucial. These businesses can evaluate the appropriate prices for their products and whether costs are tracking in line with expectations. This is done by getting a handle on manufacturing costs.

They can assess the expenses associated with each stage of the production and distribution process using process costing. They then utilise the results to pinpoint areas where costs can be cut.

One of the most popular costing techniques used by manufacturing operations is standard costing. Manufacturers must set "standard" rates for labor and materials utilized in production and/or inventory costing. This is in order to employ standard costing technique.

• The engineering department or production management is typically in charge of determining the expected rates for labor and duration periods, as well as the material use requirements needed to make a single unit.
• The task of determining acceptable overhead rates of absorption per period of production is typically left to cost accounting.
• The task of developing the standard rates for purchasing-related operations falls to the purchasing department.
• The benefit of standard costing is that it enables manufacturers to make things in accordance with a set of standards.
• This allows for monitoring and comparison of variations in actual rates or duration through the examination of variances noted at the production level.
• Manufacturers can evaluate trends and adjust their standards as necessary with the use of standard costing, which aids in making precise pricing decisions.
• This strategy also makes budgeting simpler and can rapidly alert the cost accounting division to production abnormalities.
• Companies that frequently create similar goods or those that mass produce particular goods can benefit from standard costs.
• The use of conventional costing has a number of drawbacks as well.

One that comes up regularly is how much time and money it actually takes to establish and maintain the standards that are allocated to production activities (i.e. engineering, materials, and overhead). Another is that once a standard is put in place, it always gets slightly out of date.

The method by which a manufacturer establishes that standard, however, is probably the biggest drawback to standard costing. Employees will become discouraged if your organization sets standards that are essentially impossible to meet, which could have a detrimental effect on output. In contrast, if your standards are too lax, workers might follow them, which immediately leads to lost productivity and, as a result, poorer efficiency and profitability.

Costs for both the component and the finished product must be determined when the output is made up of various combined elements. Examples of such components include televisions, auto-mobiles, or electronic devices.

When goods are sold that include numerous other processed parts, and these parts are priced differently, multiple costing, often referred to as composite costing, is a sort of accounting method employed. Each component made by a different process has a cost attached to it, just like the finished product does.

Each component or part can be costed using a different method, which is typically done. The following are some examples of products that require numerous costing: smartphones, computers, computers, cars, and airplanes.

Activity-based Costing

A costing methodology known as "activity-based costing" is a method of comparing costs based on the cost of goods and services. It links a manufacturer's resources and activity to its goods and/or services as it pertains to cost consumption. Activity-based costing, as opposed to job costing techniques, includes additional indirect costs in direct production processes to help inform pricing decisions.

• When properly implemented, activity-based costing can be a powerful tool for manufacturers. It can give manufacturers insight into which products are profitable and which are not.
• This information is useful for figuring out a product's life cycle. It can also be used to pinpoint areas where process improvement could result in higher yields for already-existing products.
• Activity-based costing proponents contend that it is a more precise way to link overhead expenses to income-generating activities, which in turn aids a manufacturer's cost-control efforts and helps it make better and more accurate judgments about the product lifecycle.
• The work and additional expense needed to achieve that degree of cost clarity, in the opinion of opponents of activity-based costing, are not justified by the supplementary advantages that would result from it.
• For instance, if your business produces a limited number of products, cost visibility and variability are typically not too challenging to achieve and/or track.

However, it is increasingly likely that activity-based costing methodologies will become more applicable and reasonable as a manufacturer's product mix grows.

Steps for Performing ABC:

• Review the Activity Analysis
• Compile all of the costs
• Follow the cost of the activities.
• Configure Output Metrics
• Examine the Costs

Features of ABC:

• Is beneficial for predicting financial starting points
• Highlights activities with High Cost
• Aids in developing and keeping track of performance indicators
• Includes the expense of carrying out any activity right now.

Costing is a subject that is primarily covered in accounting courses. Costing and management accounting have specialist courses that go in-depth on the subject. With the help of these courses, candidates are trained in the necessary and in-demand information and abilities that they will need on the job.

Unit costing, commonly referred to as single or output costing, is a technique. It is appropriate for sectors with continuous production and standardized units. This approach aims to calculate both the overall cost and the cost per unit.

A cost sheet is created while accounting for labor, material, and overhead costs. Mining, oil drilling, cement and brick making, unit production cycles, radios, washing machines, and other industries can all use unit costing.

• Unit costs typically describe the overall cost associated with producing one unit of a good or service.
• Different businesses will use different goods-centric unit cost measurements.
• A large company may use economies of scale to reduce unit costs.
• The cost serves as the starting point for a market offering price and is helpful in analyses of gross profit margins.
• Businesses optimize the market offering price while lowering unit costs in an effort to maximize profit.

A costing method known as direct costing only considers variable expenses (i.e. costs that increase or decrease proportionally with production output). It doesn't take into account fixed costs. The use of direct costing as a technique for analysis to support management's short-term price decisions has merit.

• The benefit of using direct costing is that it enables managers who aren't frequently faced with making pricing and costing choices to determine a pretty precise "minimum" price that's needed to move additional units of a particular product.
• The drawback of this strategy is that it is only effective for making snap judgments. Assuming that this strategy will produce accurate pricing and long-term profitability is a mistake.
• You need a firm grasp of overhead costs if you want to set prices for the long run.
• For long-term price choices, job costing, standard costing, or activity-based costing will produce more accurate findings than direct costing.

It is an extension of job costing. A batch is a collection of related goods. Each unit in a given batch is identical in both nature and size. As a result, each batch is costed independently and classified as a single cost unit. The cost per unit is calculated by taking the entire cost of a batch and dividing it by the batch's number of units.

Manufacturers producing biscuits, ready-to-wear clothing, spare parts, pharmaceuticals, etc. use batch costing. This strategy is used to cost items that are manufactured in batches with consistent nature and design.

Example: Procedure for batch costing in pharmaceuticals

Batch Costing Procedure: Similar to job costing, batch costing uses a costing process. The sole distinction is that a batch rather than a job is used as the cost unit.

• Each batch (or collection of identical products) is given a serial number, or batch number, for costing purposes, exactly as a work number.
• An official document called a batch cost sheet is used to present the various cost items.
• The cost of all direct materials, direct labor, and direct expenses that can be directly associated with a certain batch are all listed on the batch cost sheet. Also included is the batch's part of the overhead costs (determined on a fair basis).
• The cost per product in a batch is calculated by dividing the entire cost of a batch, as displayed on the batch cost sheet, by the total number of products in the batch.

Cost per product in the batch = Total cost of a batch / Total number of products in the batch

This concludes the technique's costing process using the continuous operation method. This method is comparable to process costing, with the exception that its cost unit is an operation rather than a process.

• This costing method is appropriate for industries with repeated manufacturing, mass production, or components that are close to completion before processing orders, resolving difficulties, or performing subsequent operations.
• Accounting professionals can better understand and manage costs by using operation costing to help organizations account for the whole cost of each operation.
• Businesses frequently strive to reduce operational expenses to the point where production is dependable and efficient while still making a profit.
• This strategy might assist businesses in maximizing their earnings because excessive operating costs may force them to overcharge for their goods.
• Companies that generate both mass-produced and customized goods may find this strategy valuable because it works well in scenarios where products require a combination of distinctive and general production processes.

A distinct method to costing is used in target costing. Target costing makes an effort to predict future expenses and how those costs will affect product price and targeted profit margins, in contrast to other "primary" costing techniques that rely on past data to determine a company's costing philosophy.

Although this method obviously does not meet US GAAP or IAS criteria for fundamental costing, it does provide value-added benefits. In the end, most manufacturers either directly or indirectly try to foresee what will happen and how that would affect the bottom line.

• It goes without saying that using a target-costing method has benefits.
• It makes sense that these producers have a greater chance to attain the desired profit margin by attempting to be proactive in product cost estimation.
• Products that fall short of the manufacturer's desired product level within the product family that it creates and sells are candidates for discontinuation.
• The drawbacks of target costing are also obvious. Future trend monitoring typically necessitates a larger team, which increases the expense of developing these costing/pricing models and can also lengthen the product development cycle.

When determining income tax or other government liabilities, costing is useful to the government. Additionally, it aids in the establishment of industry standards, the fixation of product prices, tariff planning, cost management, etc. Cost management and increasing efficiency rate are the key areas of focus in costing. Costing will therefore aid in running the business and produce significant revenues.

• Assist in understanding how important inputs and outputs are to the production process.
• A productive communications system.
• Aids in locating the true cost per unit of each product for the management.
• The government can benefit from data.
• It is useful to determine costs at different phases of production.
• It displays the revenue and expenses for each activity.
• Assists management in making judgments.
• Minimizing waste.
• It is feasible to compare performances.
• It aids in the development of a strong organizational structure.

The following are some crucial areas where an ERP or MRP (Material Requirements Planning) system can be helpful in:

• Monitor carrying costs
• Control production
• Evaluate work-in-progress costs

These solutions allow you to quickly view your manufacturing and material expenses. This simplifies your selling price computation in the end.

Why Does a Firm Need to Have a Costing Process?

To make sure that all company costs are covered and that the development and accounting teams set a price that ensures a profit, costing is crucial.

Finding all of a company's general costs—such as those associated with production, sales, administration, overhead, etc.—is the first and most crucial stage in the costing process. Next, it's important to research and analyze each department in order to determine which area of the company needs improvement.

How Does Costing Get Applied Throughout the Whole Production Cycle?

There are two primary uses for costing:

• Internal reporting - The Management utilizes costing to learn about the costs of the activities engaged in the manufacturing process in order to work on streamlining operations to increase profitability and establish product prices.
• External reporting - According to the various accounting standards, costs must be assigned to inventories on a company's balance sheet at the conclusion of the reporting period. This necessitates the adoption of a cost allocation method that is applied consistently.

There truly is no incorrect choice if it makes sense for your organization when choosing the costing approach or model that works best for a manufacturer. Manufacturers must compare the difficulty of using the strategy to achieve a targeted profit margin against the load of obtaining the costing data (whether it be historical data or attempts to predict the future).

• Historical costs should be fairly accurate for manufacturers who produce a small number of products or products that are designed or MTO because previous cost information is updated often and they have practically current costs.
• Because of this, using job costing or direct costing may be an acceptable strategy.
• Directly linking costs to a particular product can be exceedingly challenging, if not impossible, for firms who create comparable products in large quantities or who have a wider range of products.
• The more effective method in these circumstances would probably be conventional costing or activity-based costing.
• Any costing strategy, regardless of which one is most effective, provides advantages that can support precise pricing judgments. Manufacturers don't necessarily have to select one methodology over another in the current software industry.
• Experienced software providers should provide a wide range of functionality that goes beyond the bounds of conventional costing methodologies.
• They must, first and foremost, support the prevailing costing approach demanded by the manufacturer's nature.
• In order to make proper price decisions, they should have included functionality from other costing disciplines.
• Manufacturers, for instance, who primarily benefit from task costing functionality, might also profit from aspects that are typically connected to standard costing.
• The capability that would often be associated with task costing environments would be advantageous for conventional costing environments as well.
• Manufacturers must select a solution that is consistent with their costing assumptions.

However, if that decision incorporates elements from other philosophical costing systems, you'll receive more value for your money. In order to assist you make more informed pricing selections, choose goods that include the appropriate range of costing functionality.

Choosing the Best Technique

As you can see, selecting the ideal pricing approach for your company won't be simple, and the variety of available strategies won't make it any simpler. However, you'll find a succinct explanation below to assist you in making the best decision:

• If you're creating numerous standardized products in huge quantities, process costing can be the best solution.
• Target costing may be the ideal choice if you want to make sure that your products are created and priced to satisfy customer expectations.
• Job costing may be more appropriate if you're producing bespoke items or small batches of products.
• Activity-based costing may also be the best option if you're mass producing goods because the price of each unit can vary depending on the processes used to make it.

In the end, it's crucial to pick a costing approach that works for your company and gives you the data you need to make wise decisions.

What Distinguishes Cost Accounting From Financial Accounting?

In traditional accounting, profit and loss are calculated by subtracting expenses from income, whereas the goal of cost accounting is to be cost-effective by lowering project, process, and manufacturing costs.

• While cost accounting divides an organization into several processes, projects, or production units, financial accounting sees an organization as a whole.
• Cost accounting is used for internal cost analysis, whereas financial accounting is used to communicate the organization's situation to its stakeholders.
• While cost accounting methodologies differ depending on the type of firm, financial accounting is standard across all industries.

Cost of Goods Sold vs. Inventory

Where the accountant notes the difference between cost of goods sold (COGS) and inventory values serves as its representation in accounting. Companies value their inventory as a component of their existing assets at the cost to them. The COGS acronym stands for cost of products sold to customers.

On the balance sheet, accountants list the ending inventory balance as a current asset. The assets on the balance sheet increase as inventory rises. The assets on the balance sheet shrink when inventory falls. On the income statement, accountants also include the change in inventory as a component of COGS.

Some income statements are adjusted by accountants to reflect the COGS calculation as follows rather than as a COGS adjustment when inventory changes:

Beginning Inventory + Net Purchases = Goods Available for Sale - Ending Inventory

• Businesses often report inventory value at cost. A manufacturer would, however, record inventory at the cost to make the good, which would also include the expenditures of labor, overhead, and raw materials.
• Typically, inventory is one of the largest assets shown on a company's balance sheet, if not the largest asset.

Estimates and Adjustments to Inventory Valuation

When an item's future is unknown, such as when it might become obsolete, GAAP permits valuation modifications. A few techniques for these adjustments are:

• Lower of Cost or Market (LCM): Businesses track their inventory's lowest cost, which can be either the purchase price or the market price. A business must record the cost of inventory at whatever cost is lower—the original cost or its current market price—according to the lower of cost or market rule.

This problem often occurs when inventory deteriorates, becomes outdated, or when market prices fall. Due to the possibility of the aforementioned conditions developing over time, the rule is more likely to be applied when a company has stored inventory for a considerable amount of time.

• Net Realizable Value (NRV): Businesses report expected selling prices less costs associated with disposal or sale. An asset's worth is often assessed using the net realizable value (NRV) approach for inventory accounting.

It is discovered by calculating the difference between the asset's anticipated selling price and all of the expenses related to the asset's eventual sale. In terms of a formula, NRV is equal to the expected selling price minus the total production and selling expenses.

NRV = Expected selling price - Total production and selling costs.

Lastly, a few techniques determine the cost value of the final inventory:

• Retail Inventory Method: Companies use the relationship to their retail price to determine the cost of inventory that is on hand. The retail inventory technique adds up the value of the items that can be purchased, including the initial inventory and any new purchases of inventory, to get the ending inventory value.

The commodities available for sale are deducted from the total period sales. The cost-to-retail ratio, often known as the proportion by which items are marked up from their wholesale purchase price to their retail sales price, is multiplied by the difference.

• Gross Profit Method: Businesses use a ratio to sales to determine their inventory level and COGS. The gross profit approach uses current-period data on net sales and the cost of products available for sale along with the company's historical gross profit percentage to estimate the value of inventory.

Net sales - cost of goods sold = gross profit.

The cost-to-retail ratio of a business may differ dramatically from one type of item to another, but the computation only takes an average ratio. This is one drawback of the retail inventory technique. The estimate will be incorrect if the cost-to-retail ratio of the items that actually sold is significantly different from the ratio utilized in the computation.

Manufacturing overheads can be the trickiest to estimate of all the costs mentioned. All indirect expenses incurred in operating a firm, such as rent, utilities, and insurance, are referred to as overheads. Since they are not directly related to the creation of goods, overheads are considered indirect expenses.

The following are the top five manufacturing overheads:

• Indirect labor- The cost of all employees who are not specifically employed in the production of the good, such as managers, secretaries, and janitors.
• Indirect materials- Such as packaging and labels, are materials utilised in the manufacturing process but not directly in the creation of the finished product.
• Physical costs- All the costs associated with maintaining your factory.
• Utilities- The cost of the energy, water, and gas needed in production. such property taxes, insurance, and rent.
• Financial costs- Including any accounting, banking, and legal fees.

You must tally up all the indirect charges to determine the overall cost of the overheads. The distinction between fixed and variable overheads must be kept in mind:

Fixed overheads- Such as rent, are expenses that are constant regardless of the volume of output.

Variable overheads- Like electricity that fluctuate in line with production. You must divide the total overhead expense by the quantity of units produced in order to determine the overhead cost per unit.

Overhead cost per unit = Total overhead cost / Number of units produced

You must determine the overhead cost per unit for each product if you are producing a variety of goods. This is because the cost of overhead per unit will vary depending on the production expenses of each product.

The choice of how to distribute overheads is a crucial one. This is due to the fact that overheads can significantly affect a product's profitability. Incorrect overhead allocation can result in products being overpriced or underpriced.

How can Deskera Help You?

As a manufacturer, you must keep track of your inventory stock. The condition of your inventory has a direct impact on production planning, people and machinery use, and capacity utilization.

Deskera MRP is the one tool that lets you do all of the above. With Deskera, you can:

• Control production schedules
• Compile a Bill of Materials
• Produce thorough reports
• Make your own dashboard.

Deskera ERP is a complete solution that allows you to manage suppliers, track supply chain activity in real time, and streamline a range of other company functions.

Deskera Books allows you to manage your accounts and finances better. It helps maintain good accounting standards by automating billing, invoicing, and payment processing tasks.

Deskera CRM is a powerful tool that organizes your sales and helps you close deals rapidly. It enables you to perform crucial tasks like lead generation via email and gives you a comprehensive view of your sales funnel.

Deskera People is a straightforward application for centralizing your human resource management activities. Not only does the technology expedite payroll processing, but it also helps you to handle all other operations such as overtime, benefits, bonuses, training programs, and much more.

Costing is essential for management to make informed decisions, plan and control operations, and put in place efficient cost management strategies due to the growing complexity of businesses and changes in the industries.

All product-related costs must be included in the inventory line item on a company's balance sheet if it is preparing financial statements. The appropriate accounting framework, which is expected to be either GAAP or IFRS, lists the broad categories of costs to include.

Because an allocation of factory overhead is a crucial component of these cost inclusions, products that are costed to adhere to accounting rules are probably going to have the highest cost per unit.

• The statement known as a cost sheet details the numerous costs that make up a product's overall price. In addition to total cost, it also displays per unit cost. A cost sheet is created using predicted and historical costs.
• When each project is unique and the cost of each job fluctuates, job costing is used to keep track of expenditures. In this approach, both direct and indirect expenses are included.
• When there are only minor variations in a product's design, mass production firms who use process costing can better track expenses.
• A method that just accounts for variable production costs is known as direct costing, sometimes known as variable costing. Raw materials and labor are examples of variable costs because they fluctuate depending on the volume of output.
• A technique for ensuring that items are created and priced to satisfy client expectations is target costing.
• Businesses need to be aware when growing production leads in step costs because of changes in relevant ranges (i.e. additional machinery or storage space needed).

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The Ultimate Guide to Project Cost Management with Templates

By Kate Eby | April 25, 2017

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Your organization’s projects are critical to its future. Sound cost management enables you to make optimal use of your resources (time, personnel, equipment, and materials), make data-driven decisions about projects and their risks, measure financial performance, and provide key metrics to senior management.   This definitive guide to project cost management includes templates for key activities like cost estimating and creating a cost management plan. You’ll learn important terms, best practices, and subtle distinctions (such as the difference between cost management and strategic cost management), as well as how cost management works in specialized cases, like construction and IT projects.

What Is Project Cost Management?

Whether you are developing a new product, designing a facility, or changing a key process, it’s challenging to forecast and manage project costs effectively.   In fact, the job is so challenging that half of all large IT projects massively blow their budgets , running on average 45 percent over budget and seven percent over time, according to consultants McKinsey & Co. and the University of Oxford. For projects in other sectors, the news is no better. The Project Management Institute (PMI) reported in 2016 that companies were completing only 53 percent of projects within their original budget. However, strong cost management helps you avoid that fate. So what exactly is cost management?   Cost management refers to the activities concerning planning and controlling a project’s budget. Effective cost management ensures that a project is completed on budget and according to its planned scope. Since you assess the success of a project at least in part by its cost performance, cost management is a prime determinant of project outcome.   Cost management activities are conducted throughout the project life cycle, from planning and budget allocation to controlling costs during project execution and assessing a project’s cost performance upon completion.   Although cost management includes a whole ensemble of activities, it is sometimes referred to in terms of more specific functions, such as spend management, cost accounting, and cost transparency. Cost managers sometimes use these terms as loose synonyms for the broad cost management function.

Cost Management: Four Major Steps

The Project Management Body of Knowledge (PMBOK), the bible of project management theory, says cost management is made up of four processes. These generally adhere to the sequence that follows — as a project goes from the planning board to reality.

• Resource Planning: Part of the initiation stage of a project, resource planning uses a work breakdown structure — a hierarchical representation of all project deliverables and the work required to complete them — to calculate the full cost of resources needed to complete a project successfully. Managers typically determine required resources for each work breakdown structure component and then add them to create a total resource cost estimate for all project deliverables.
• Cost Estimating: Cost estimating is an iterative process that uses a variety of estimating techniques to determine the total cost of completing a project. Cost estimating techniques vary widely in their approaches to computing project costs, and stretch from conceptual techniques that draw mainly from historical experience and expert judgment to determinative techniques that estimate costs on a component-by-component basis. We will discuss these techniques in detail later, as they vary in their levels of accuracy. Determinative techniques are the most accurate; however, while the estimator’s job is always to create the most accurate estimate possible, determinative estimating techniques are only an option if you’ve reasonably finalized a project’s scope and deliverables. As such, you use the less accurate estimating techniques during the earliest stages of project planning, and then revise and update estimates as the project continues to be defined. To learn more about cost estimating, read The Ultimate Guide to Project Cost Estimating . 
• Cost Budgeting: Once you’ve created satisfactory estimates, you can finalize and approve the project’s budget. Cost managers typically release budgeted amounts in stages according to the level of a project’s progress. These allocations include contingencies and reserves.
• Cost Control: Cost control is the practice of measuring a project’s cost performance according to cost and schedule baselines that provide points of comparison throughout the project life cycle. The specific requirements for effective cost control are set out in the project management plan. The individual in charge of cost management investigates the reasons for cost variations - if they deem cost variations unacceptable, corrective action is likely. Cost control also includes other related responsibilities, such as ensuring that updated project budgets reflect changes to a project’s scope.

Key Components of the Cost Management Plan

The cost management plan guides these four processes. Created during the project planning phase, the cost management plan is a document that defines how you manage, control, and communicate a project’s costs in order to complete the project on budget.   Among other things, a cost management plan identifies the individual or group responsible for cost management, details how you will assess a project’s cost performance, and sets rules for how to communicate cost performance to project shareholders. It also establishes the methodologies by which you will control project cost variations.   While you can customize a cost management plan to fit your organization’s needs, they generally follow a standard format. Sections often include the cost variance plan, the cost management approach, information on cost estimation, the cost baseline, cost control, and reporting processes, the change control process, the project budget, and approvals. You may also want to include the spending authority levels for key project personnel, specifying which roles can approve costs up to specific thresholds.   Let’s look at the sections in greater depth:

• Cost Variance Plan: Cost variance is when the actual amount differs from the budgeted amount. In your cost management plan, you’ll need a section that details the actions you should take, including who is held responsible in the case of a cost variance. The size of the variance usually necessitates different action: a cost variance of less than five percent might result in an explanation of that variance, while a 95-percent-or-greater variance could force the project to be abandoned. To learn how to calculate cost variance, read Hacking the PMP: Studying Cost Variance . For a more detailed template on tracking schedule and budget variances, see this template:
• Cost Management Approach: This section outlines the approach a manager uses for cost management. The level of rigor can vary, but this describes how to establish a cost baseline and how to compare actual costs. You usually track and report costs through control accounts, where you roll up costs of subtasks. This often occurs at the third level of the work breakdown structure, a tool that breaks a project into small components or chunks of work to determine the resources needed to complete a job or project. However, the point at which you track and report depends on the scope of the project.
• Cost Estimation: Here you will define the methods used for estimating project costs, the levels of variation, and the expected precision, accuracy, and risk.
• Cost Baseline: This has a specialized meaning in project management and represents the authorized, time-phased spending plan against which you measure cost performance. It’s the sum of the estimated project cost and contingency reserves. 
• Cost Control and Reporting Process: This section establishes how you measure costs and their key metrics during the project. We’ll provide greater detail on this later.
• Change Control Process: This describes the process for making changes to the cost baseline and how to approve those proposed changes.
• Project Budget: The budget builds on the cost baseline by totalling the cost of executing the project (including contingencies for possible risks). It also adds in management reserves, which is an amount to cover unanticipated risks or unidentified events that may arise. An organization will usually set a policy for this, and the amount is often five to 15 percent of the total budget.

Cost Management Activities: Essential Functions at Each Phase

Cost management includes a number of activities conducted at different phases during the project life cycle. It’s important to include the cost management function while developing project plans so that you build solid financial controls into the project structure. Here are some key terms and stages relevant to cost management:   Planning: Using the work breakdown structure to determine the resources needed to complete a job or project.   Estimating: The act of calculating or predicting the expected total cost of completing a project.   Budgeting: The authorization of a budget based on a cost estimate to complete the project. You typically authorize budgets in tandem with schedules, so you can assess cost performance at specific points.   Financing and Funding: The process of requesting, authorizing, and receiving money for a project.   Cost Management: The general practice of overseeing project expenditures and making cost-related decisions throughout the project life cycle.   Controlling: Addressing cost variations to avoid cost overruns.   Job Control: Controlling project expenditure by comparing costs predicted by the cost estimate and costs actually being incurred.   Scheduling: You can determine a project’s cost performance by using a schedule that compares the expected expenditure to the actual costs the project is incurring at any point in time.   Accounting: The practice of recording expenditures and reconciling transactions.

How Accurate Project Cost Estimating Aids Cost Management Efforts

The first step towards robust cost management is having a clear idea of your project’s likely costs. However, it’s futile to track and control costs if you base your spending on unrealistic estimates.   Project estimating considers several variables, including the method you use to create the estimate, the stage at which you build your estimate, and the types of cost you include.     The first variable is the method you employ. You can produce cost estimates using a variety of estimating techniques, depending on the extent to which you define a project and the type of information you have access to. Here are some common estimation techniques:

Analogous Estimating: This uses historical data from similar past projects to create estimates for new projects. This method works if you have experience with projects of the same type.

Parametric Estimating: This method estimates time and cost by multiplying per unit or per task amounts by the total number expected in the project. The rates are often standard or publicly published rates and can be expressed in hours of work, amount of data entered, or the number of units of a product manufactured. This technique has a reputation for good reliability, but it’s less relevant when output isn’t uniform, such as when writing computer code. Some projects have widely varying or unprecedented tasks, so they do not lend themselves to this method.

Bottom-Up Estimating: This is a determinative estimating technique that estimates costs for work breakdown structure components and adds them together to create a cost estimate for an entire project. The project team members help create the estimate. Since the people who are going to be doing the work are engaged in estimating, professionals consider this method highly accurate, as well as a team commitment builder.

Three-Point Estimating: This is a PERT -related statistical method that uses the optimistic (lowest), pessimistic (highest), and most likely cost estimates to create expected values and standard deviations for project expenditures.

Software-Based Estimating: You can use software-based estimating techniques, such as Monte Carlo simulation, to model the effects of risk events on project costs.   Another factor influencing the cost estimating is the stage at which you build your cost estimate. As a project progresses, you discover more variables and actual costs, so project estimates become more refined. You can classify cost estimates based on how well you define the project scope at the time of estimation and on the type of estimation technique you use - the latter generally determines the accuracy of an estimate. In order of accuracy, the main classes of cost estimates are:   Order of Magnitude Estimates: These are very rough cost estimates based on expert judgment and on adjusting the costs of the current project to reflect the costs of similar, past projects. Created before fully defining projects, they are only used in high-level project screening.   Preliminary Estimates: A preliminary estimate uses somewhat-detailed scope information to form estimates based on unit costs. These estimates are accurate enough to use as the basis for budgeting.   Definitive Estimates: Created when you’ve fully defined a project’s scope, a definitive estimate uses deterministic estimating techniques, such as bottom-up estimating. Experts agree that definitive estimates are the most accurate and reliable.   The final variable affecting project estimation is the type of cost included. Of course, your project budget must include all the relevant costs for labor and materials, but whether you include a portion of your organization’s indirect costs depends on the policies of your organization and the type of project. Here are the terms experts use to distinguish between various types of costs:   Direct Costs: Direct costs are those which you can directly associate with a specific cost object. They are billable to specific projects.

Indirect Costs: You cannot associate indirect costs with a specific cost object, and you typically incur indirect costs by a number of projects at the same time. They are not billable to specific projects.

Fixed Costs: Fixed costs are costs you incur during manufacturing that are not associated with the volume of produced output.

Variable Costs: Variable costs are costs you incur during manufacturing that are directly associated with the volume of produced output.

Sunk Cost: A sunk cost is an expense you cannot recoup once it is incurred.

Opportunity Cost: When selecting a course of action, its opportunity cost is the loss of potential benefits from all alternative courses of action.

Costing Techniques Determine How to Account for Project Costs

A costing technique is the way in which you compute the total cost of producing a product or performing a task. Depending on the activity or activities being costed, you may use a variety of techniques. Here are some commons ones:   Job Costing: Managers use job costing, also called job-order costing, to determine the cost of a product that is unique or dissimilar to other products. In industries such as construction, it’s extremely rare for two jobs to be identical. Job-order costing uses a unique job-cost record that compiles total labor and resource costs, as well as applicable overheads, for each task or activity completed as part of a task to determine total expenditures for the job. The job-cost record includes both direct and indirect costs.   Process Costing: You use process costing to determine costs for products or tasks that are identical. Unlike job costing, it does not compute the total cost of a product by summing up the costs of all tasks and activities that go into creating the product. Instead, process costing looks at the processes included in the mass production that creates products. By dividing the total cost of a process by the number of units output, it is possible to determine the cost per unit of each process. After this, you may total the costs per unit of every process involved in the eventual manufacturing of the product. In this way, you compute the cost per unit of each product on a process-by-process basis.   Activity-Based Costing: Activity-based costing (ABC) is an approach to assigning overhead costs to products. Since overhead cost allocation based simply on the number of machine hours needed may be misleading, this costing technique looks at the activities focused on creating a product — testing, machine setup, etc. — and then assigns portions of their costs to all products created using these activities. Products that were not created via these activities do not have shares of these activities’ costs added on.   Direct Costing: Direct costing, also called contribution costing or variable costing, is a technique that only assigns variable manufacturing costs to the cost of a product. You do not add fixed manufacturing costs to the cost of creating a product but instead associate those costs with the time period during which you incur them.   Life-Cycle Costing: Life-cycle costing is a comparative analysis technique that involves summing the total costs incurred during the life cycles of project options in order to choose the best option. Since starting capital costs may not be an accurate representation of how much a project will eventually cost, life-cycle costing includes all costs associated with ownership — including maintenance and disposal costs — to enable better decision making. 

Measuring Project Performance With Cost Management KPIs

Once your budget is approved and your project is under way, you’ll want to benchmark your progress relative to your cost management plan. First, there are some key metrics and performance indicators to understand:     Project Cost Performance: A project’s cost performance is an assessment of how actual expenditure on a project compares with planned expenditure as detailed in the project budget. The project manager communicates a project’s cost performance to the project stakeholders, and it may serve as the basis for preventative or corrective actions to avoid cost overruns.   Earned Value: Earned value is a method of measuring project cost performance. It is based on the use of planned value (where you allot specific portions of a project’s budget to the project tasks), and earned value (where you measure progress in terms of the planned value that is earned upon completion of tasks). You may contrast the earned value with the actual cost -  the expenditure you actually incur up to a certain point in the project schedule - to see how actual project costs compare to expected project costs.   Cost Performance Index (CPI): This is a measurement of how earned value compares to actual cost. This ratio measures a project’s cost efficiency at a given point in time by expressing earned value in proportion to actual cost. To calculate CPI, divide earned value by actual cost. A result of 1 means the project is exactly on budget; a number above 1 means it is under budget.

To learn more about KPIs in project management, read All About KPI Dashboards .

How to Control Costs

Effective cost control means performing a number of related activities that all begin by monitoring costs — since you can’t know if costs are greater than planned unless you are tracking actual expenses. Then, project managers need to decide how to respond to cost variances. Here are some key steps and concepts that inform the cost control process:   Monitoring Cost Performance: A project manager routinely monitors a project’s cost performance by creating performance reports that summarize current performance and forecast whether you will complete the project on budget. You provide project stakeholders with information about a project’s cost performance.   Reviewing Changes: You must amend the cost baseline to reflect all cost-related changes, and you should inform the project shareholders about all changes.   Actual Costs versus Budgeted Costs: Upon milestone and entire project completion, you examine the variances between actual costs and budgeted costs. Responses to the cost management plan will depend on the magnitude of the variance and the stage of the plan - this could range from a discussion to changes in the project scope that reduce costs.   Reserve Analysis: Use reserve analyses to allocate contingency reserves to projects based on the likelihoods and magnitudes of risk.   Cash-Flow Analysis: Used in financial reporting, cash-flow analyses detail cash inflows and outflows over a given period of time, and provide starting and ending balances.   Learning-Curve Theory: The learning-curve theory applies to the relationship between the time spent producing a unit and the number of units produced. According to the theory, the time spent on each unit should decrease as workers gain experience and therefore produce units faster.   

Cost Management vs. Strategic Cost Management

While cost management reduces expenses regardless of their cause or purpose, strategic cost management is a sub-discipline that strives to manage cost while also making the organization stronger.    Robin Cooper, Professor of Management at Claremont’s Peter F. Drucker Graduate Management Center and Regine Slagmulder, Professor of Management Accounting at Tilberg University in the Netherlands, define strategic cost management as the “application of cost management techniques so that they simultaneously improve the strategic position of a firm and reduce costs.”   Strategic cost management centers on the idea that cost reduction initiatives can affect an organization’s strategic position. Strategic cost management emphasizes considering the strategic and financial impact of cost management techniques.   Cooper and Slagmulder classify cost management initiatives as one of three types based on how the initiative affects the organization:   Strengthen: An example of an initiative that strengthens competitive positioning is a taxi service that replaces its phone booking system and team of booking agents with an app that allows people to book taxis using their mobile devices. An initiative like this both reduces costs and gives a company a strategic advantage, as it makes it easier to book taxis on short notice.   No effect: An initiative that has no effect on competitiveness might concern a publishing house that outsources proofreading tasks to international freelancers who accept lower wages. While this increases the company’s profitability, it does not affect its strategic positioning.   Weaken: Finally, an initiative that actively harms competitive positioning might involve the taxi company decreasing the frequency of regular vehicle maintenance, a move which, while saving costs initially, will result in cars breaking down more often.   Strategic cost management also comprises a number of important strategies:   Relevant Cost Strategies: Use relevant cost strategies to compare and decide between alternative courses of action. Relevant costs are costs you can reduce by adopting a particular course of action. They are different from sunk costs (which you cannot recoup once spent) and fixed overhead costs (which are the same for all potential courses of action). When you make decisions, a relevant costs strategy focuses only on costs that vary among options.   Evaluating Opportunity Costs: Evaluating opportunity costs is a more holistic approach to decision making that considers not only all the monetary aspects of alternative courses of action, but also all the intangible aspects. For example, a company providing vehicle repair services might have to decide between two qualities of engine oil, taking into account both that one is more expensive than the other and that the more expensive engine oil also preserves engine health in the long term.   Balanced Scorecard Strategy: A balanced scorecard strategy allows businesses to assess the impact of cost management initiatives across four key areas: financial results, customer impact, internal business processes, and employee growth and development. It provides a framework for thorough consideration of the impacts of cost management initiatives. 

Getting Into the Details: Cost Accounting in Project Cost Management

Cost accounting involves the recording and classification of costs associated with a project. It is an internal practice that supports managerial decision making and is a primary discipline concerning cost management.

Cost accounting is different than general financial accounting. Financial accounting concerns  reporting an organization’s past financial performance and does not delve into extensive detail. Since you carry out cost accounting for a specific area of activity within a company — such as a particular project or geographical region — it focuses on more granular aspects and may include projections of future costs.   Cost accounting involves preparing reports for an organization’s management (these reports are not distributed externally). By contrast, financial accounting deals with standardized reports that may be distributed to a variety of stakeholders and regulators.   As such, you typically perform cost accounting on an as-needed basis, such as during a strategic project, and it does not follow a mandated format. Financial accounting, on the other hand, is a mandated and regulated formal process, and you must create financial reports according to international financial reporting standards.   There are a few commonly used cost accounting approaches:   Standard Cost Accounting: This is based on the concept of efficiencies , or ratios that compare the time and resource costs of actually completing an activity with the costs of completing the activity under standard conditions. Variance analysis is a core element of standard cost accounting. However, since the idea of efficiencies is based on a paradigm in which labor costs contribute substantially to manufacturing — which is no longer the case — standard cost accounting is somewhat outdated.   Activity-Based Costing: This is an approach to assigning overhead costs that examines activities that provide a service, execute a task, or create a product, and then assigns portions of their costs to output.   Resource Consumption Accounting (RCA): This approach emerged around 2000, and assigns costs based on the consumption of resources. It uses a German cost management system known as GPK and activity-based costing, a cost allocation method.     Throughput Accounting: This is an accounting approach that aims to maximize profitability by increasing the rate of production of goal units and minimizing operating expenses and investment costs.   Life-Cycle Costing: This is a method of analyzing project alternatives that focuses on total costs of ownership and selecting the most cost-effective option based on more than simple capital costs.   Environmental Accounting: Reporting the environmental costs incurred by a company or project’s activities.   Target Costing: This uses a predetermined market price and preferred profit margin to determine how much money can be used to create a product or service. The target cost is the maximum amount you can spend on production without affecting the profit margin.    Cost Coding: To make cost accounting easier, most organizations have adopted a method of identifying costs with a code, usually a number. The root of the code usually represents the type of expense, cost center, or business unit involved. This makes it easier to group and find related expenses in financial reports. Individual projects may be assigned their own code.   A common structure in an enterprise or very large organization is a top-level, four-digit code that relates to the accounting entity (for example, a subsidiary company). The next numbers pertain to department, followed by a number for the cost, which can be a cost center, profit center, work-breakdown-structure element, fund, or internal order. This facilitates the cost management process by aligning the cost codes with the work breakdown structure, which makes it easier to calculate financial performance.   In addition, costs in cost accounting may be classified by:  

• Traceability: Direct and indirect costs
• Behavior: Fixed or variable costs
• Controllability: Controllable or uncontrollable costs
• Time Incurred: Historical or predetermined costs
• Normality: Normal or abnormal costs
• Functions: The organizational function by which you incur a cost

  Cost accounts make it easy to identify cost overruns in specific sectors that might otherwise be lost in a budget overview. However, managing a large number of cost accounts — up to several hundred accounts and sub-accounts on larger projects — comes with its own challenges. It demands a higher degree of organization in accounting, for one, and classifying costs becomes more time consuming.   In addition, the system of categorization you use for a project’s cost accounts may not match up with the system of categorization you use for an organization’s cost accounts. This complicates the creation of a project budget from a final cost estimate, and is likely to happen when you create cost accounts using a system of categorization different than the performing organization uses.

Aside from recording historical expenditure, project managers must also forecast expected activity costs to ensure that they remain under control. Managers can do this through the use of tables that classify costs for individual cost accounts and cost modeling techniques that indicate whether work associated with a particular activity is due to be completed on budget.

Software’s Role in Project Cost Management

Cost management software simplifies and expedites project cost management activities. This can ease the burden on project cost managers and make it easier to extract insights, such as the cost performance index. Some of the common functionalities include:   Project-Tree Building: A visual representation of a work breakdown structure. This can be useful when employing deterministic estimating techniques.

Cost Estimation: Cost management software can provide powerful estimation capabilities such as using project trees to record activity costs, or running regression analyses to determine cost-estimate relationships in historical data.   Project Cost Management Templates: For projects that are similar, cost management ]templates can expedite cost management activities.   Budgeting: Cost management software can make it easier for project managers to conduct budget planning activities and allocate funding. 

Keep Projects On-Budget Using a Cost Management Template

One tool that can help with project cost management is Smartsheet, a collaborative work management and automation platform. As a cloud-based platform, you can share and collaborate on your cost management activities with internal and external stakeholders, and access the information from anywhere, on any device. 

Plus, with a pre-built, customizable template in Smartsheet, you can get started faster than ever. Track project and budget performance all in one sheet. Use symbols to quickly identify tasks that may be at risk of going over budget, and bring visibility to status of estimated versus actual labor, materials, and other costs. Set up alerts and reminders to notify you as costs change, and attach documents like invoices and purchase orders directly to tasks, to keep details in context.

Try one or all of the following templates to help ensure your next project stays on budget: 

Project Budget Template

‌ Download Project Budget Template

Excel | Smartsheet

Cost Management Plan Template

Download Project Cost Management Template

Activity Cost Estimate Template

Download Activity Cost Estimate Template

‌ Smartsheet Project with Schedule & Budget Variance Template

Cost Management for IT Projects

IT project costs are notorious for going over budget, mainly because of development approaches that allow scope creep during the product development life cycle. There is also a tendency for IT cost estimates to be less fixed than those of hard projects in fields such as construction and engineering, where maturity in planning and estimating is higher. In Information Technology Project Management , Kathy Schwalbe suggests that the people creating cost estimates for IT projects lack experience compared to specialist cost surveyors who create cost estimates for construction projects.   Furthermore, given how multifaceted these projects tend to be and how quickly IT evolves, IT projects often suffer from the “first-time, first-use penalty,” which means that it is hard to form accurate estimates when a project or project elements have not been attempted before. This makes documenting lessons learned crucial for IT projects.   The U.S. research and advisory firm Gartner creates a research report for the project and portfolio management market that categorizes vendors into four categories based on their ability to understand market needs and to drive the acceptance of new technologies. These are graphed on axes labeled “completeness of vision” and “ability to execute,” respectively. The “magic quadrant” is the upper right of this graph in which leaders in both areas cluster.  

Cost Management in Construction Projects

Construction project cost managers, or quantity surveyors, oversee cost estimation and cost control while maintaining a project’s profitability. They are responsible for ensuring that a project remains within budget while meeting its scope, quality, and performance requirements.   Though the majority of construction projects are not subject to the “first-time, first-use penalty,” they are still highly complex. And as hard projects, their design, scope, and budgetary requirements must be planned before work begins. Experience and formal training are essential for quantity surveyors.   The evaluation and recommendation of bids is one of the quantity surveyor’s primary responsibilities, though they may be engaged in a project from inception to conclusion. In fact, quantity surveyors get their name from the bill of quantities , a cost estimate prepared by the surveyor and by which contractors’ tenders are assessed.

To aid cost management for large, complex projects, quantity surveyors or project managers may use cost codes discussed earlier to set up multiple cost accounts. These accounts are essentially portions of budget marked for specific expenses such as labor, construction materials, architectural design, etc.

Home Construction Budget Template

Download Construction Budget Template

Excel |  Smartsheet

Construction Estimator Template

Download Construction Estimator Template

Excel  ‌| Word | PDF |  Smartsheet    

Exploring Cost Management as a Career

Professional cost managers, sometimes called quantity surveyors, work on large projects (such as construction). But project managers also need an understanding of cost management strategies and techniques to perform their duties.   Cost management requires creative problem-solving skills and a thorough understanding of the factors that affect project costs. As such, cost managers are in high demand and have opportunities to progress to lead project managers.   One popular cost management profession is cost accounting, which is determining the costs focused on creating a product or providing a service. Cost accountants deal with budget preparation and profitability analysis, and their main responsibilities include collecting and communicating cost-related data to aid management decision-making and create financial transparency.   Cost accountants typically study accounting or finance at the undergraduate level, and many pursue master’s degrees in business administration or finance with a specialization in accounting. They typically need a license to advance their careers, which can be obtained after meeting some combination of work and educational requirements.

How Smartsheet Can Help with Cost Management Across Your Projects

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When teams have clarity into the work getting done, there’s no telling how much more they can accomplish in the same amount of time. Try Smartsheet for free, today.

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Cost Accounting 101: Understanding Product Costs and Pricing

Cost accounting is a systematic set of procedures  manufacturers  use for recording and reporting measurements of the cost of manufacturing goods and performing services.  It includes methods for recognizing, classifying, allocating, aggregating and reporting such costs and comparing them with standard costs.

Cost accounting was originally developed to help manufacturers estimate the full costs of manufactured goods.  “Costs” include the variable costs of the labor and raw materials needed for production, as well as the fixed costs.  The total of these costs, divided by the number of units produced, represents the per-unit cost.  As manufacturers increased the range of goods and services they provided and new technologies and management philosophies arose, costs became more difficult to assign.

Purpose of Cost Accounting

An effective cost accounting system is needed to determine the “true” cost of a product, which is critical for all manufacturers in order to:

• Properly assign costs to inventory items for financial statement purposes.

• Determine sales price for products.

• Identify money makers/money losers.

• Compare different options for product mix

• Locate opportunities for cost improvement or reduction.

• Assist in the preparation and actualization of a business plan that includes an economic breakeven point.

• Improve strategic decision making.

How Effective is Your Product Costing?

It’s likely that many  small or mid-sized manufacturers  are putting themselves at considerable risk through the use of outdated costs if products have not been updated to take into account ongoing changes in the way the Company’s products are made.  Consideration needs to be given to the cost impact of new technologies or recently-added business overhead.  A periodic review should be conducted where individual product costs are reevaluated and overhead application rates and costing practices are adjusted accordingly. 

The first step to determining how effective your product costing is involves a determination of what your most profitable and least profitable products and customers are.  Communication with management and the sales department can go far to create a more profitable product mix and provide valuable input, whereby sales prices can be properly adjusted.  Product profitability analysis drives corporate profitability; a function that is entirely controllable by management.

Methods of Cost Accounting

There are several different cost accounting approaches that may be considered before implementing a cost accounting system.  Traditional cost accounting is most effective for manufacturers with homogeneous products that have very few differences in the manufacturing process.  This method assumes that there is a relationship between overhead and some volume-based measure, such as direct labor dollars/hours or machine hours.  Advanced traditional cost accounting uses multiple factors as a base for allocating overhead and can significantly improve costing.  Activity-based costing is a practical tool that can be used by manufacturing companies of all sizes to not only better determine the cost of their products, but also to better understand why those products cost what they do.

Factors for Determination of Market Price

When determining the right market price for your product, it’s important to know what your competition is doing.  Maintaining a history of your competition’s pricing and price changes will assist you in anticipating their future decisions and allow you to react accordingly.  Considering your customers’ feedback is another valuable source of data to use in your pricing strategy.  Your sales force should be seen as a resource to provide management with information related to customer satisfaction and for reactions on product quality and value.

In summary, understanding key factors impacting product costs and pricing is a critical function for any organization and will ensure that your organization has the information it needs to maintain or improve its competitive position.

Brian W. Johnson, CPA, CFE , is an audit partner with over thirty combined years’ experience providing audit and accounting services to both private and publicly-held domestic and foreign companies.  He has extensive experience in a variety of industries including manufacturing, inventory and cost accounting, construction contractors, fraud and forensic examination, audits of the controls of service organizations (SOC), internal audit outsourcing and internal controls evaluation and consulting.

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Blogs & articles, how to write a pricing strategy for my business plan.

In this blog you will learn about the importance of choosing the right pricing strategy for a successful business plan.

Why is a pricing strategy important for a business plan?

A business plan is a written document outlining a company’s core business practices – from products and services offered to marketing, financial planning and budget, but also pricing strategy. This business plan can be very lengthy, outlining every aspect of the business in detail. Or it can be very short and lean for start ups that want to be as agile as possible.

This plan can be used for external investors and relations or for internal purposes. A business plan can be useful for internal purposes because it can make sure that all the decision makers are on the same page about the most important aspects of the business.

A 1% price increase can lead to an 8% increase in profit margin.

A business plan could be very lengthy and detailed or short and lean, but in all instances, it should have a clear vision for how pricing is tackled. A pricing strategy ultimately greatly determines the profit margin of your product or service and how much revenue the company will make. Thorough research of consultancy agencies also show that pricing is very important. McKinsey even argues that a 1% prices increase can lead up to an 8% increase in profits. That is a real example of how small adjustments can have a huge impact!

It is clear that each business plan should have a section about pricing strategies. How detailed and complicated this pricing strategy should be depends for each individual business and challenges in the business environment. However, businesses should at least take some factors into account when thinking about their pricing strategy.

What factors to take into account?

The pricing strategy can best be explained in the marketing section of your business plan. In this section you should describe what price you will charge for your product or service to customers and your argumentation for why you ask this. However, businesses always balance the challenging scale of charging too much or too little. Ideally you want to find the middle, the optimal price point.

The following questions need to be answered for writing a well-structured pricing strategy in your business plan:

What is the cost of your product or service?

Most companies need to be profitable. They need to pay their expenses, their employees and return a reasonable profit. Unless you are a well-funded-winner-takes-all-growth-company such as Uber or Gorillas, you will need to earn more than you spend on your products. In order to be profitable you need to know how much your expenses are, to remain profitable overall.

How does your price compare to other alternatives in the market?

Most companies have competitors for their products or services, only few companies can act as a monopoly. Therefore, you need to know how your price compares to the other prices in the market. Are you one of the cheapest, the most expensive or somewhere in the middle?

Why is your price competitive?

When you know the prices of your competitors, you need to be able to explain why your price is better or different than that of your competitions. Do you offer more value for the same price? Do you offer less, but are you the cheapest? Or does your company offer something so unique that a premium pricing strategy sounds fair to your customer? You need to be able to stand out from the competition and price is an efficient differentiator.

What is the expected ROI (Return On Investment)?

When you set your price, you need to be able to explain how much you are expeciting to make. Will the price you offer attract enough customers to make your business operate profitable? Let’s say your expenses are 10.000 euros per month, what return will your price get you for your expected amount of sales?

Top pricing strategies for a business plan

Now you know why pricing is important for your business plan, “but what strategies are best for me?” you may ask. Well, let’s talk pricing strategies. There are plenty of pricing strategies and which ones are best for which business depends on various factors and the industry. However, here is a list of 9 pricing strategies that you can use for your business plan.

• Cost-plus pricing
• Competitive pricing
• Key-Value item pricing
• Dynamic pricing
• Premium pricing
• Hourly based pricing
• Customer-value based pricing
• Psychological pricing
• Geographical pricing

Most of the time, businesses do not use a single pricing strategy in their business but rather a combination of pricing strategies. Cost-plus pricing or competitor based pricing can be good starting points for pricing, but if you make these dynamic or take geographical regions into account, then your pricing becomes even more advanced!

Pricing strategies should not be left out of your business plan. Having a clear vision on how you are going to price your product(s) and service(s) helps you to achieve the best possible profit margins and revenue. If you are able to answer thoughtfully on the questions asked in this blog then you know that you have a rather clear vision on your pricing strategy.

If there are still some things unclear or vague, then it would be adviceable to learn more about all the possible pricing strategies . You can always look for inspiration to our business cases. Do you want to know more about pricing or about SYMSON? Do not hesitate to contact us!

Do you want a free demo to try how SYMSON can help your business with margin improvement or pricing management? Do you want to learn more? Schedule a call with a consultant and book a 20 minute brainstorm session!

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4 Tips for keeping your pricing manageable

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How To Price Your Products: 5 Most Common Strategies

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Planning, Startups, Stories

Tim berry on business planning, starting and growing your business, and having a life in the meantime., business plan financials: starting costs.

It’s really important to have an idea of what you need before you start. Continuing with my series on standard business plan financials , startups need to project starting costs. Starting costs set up a starting balance, which is necessary to plan cash flow. And the starting costs are critical to determining whether a startup can bootstrap or needs outside funding. For existing companies that already have financial results, projections start with the expected ending balance of the previous period. But for startups, it’s about starting costs.

Starting costs are essentially the sum of two kinds of spending. You can estimate them both in two simple lists:

• Startup expenses : These are expenses that happen before the beginning of the plan, before the first month of operations. For example, many new companies incur expenses for legal work, logo design, brochures, site selection and improvements, and signage. If there is a business location, then normally the startup pays rent for a month or more before opening. And if employees start receiving compensation before the opening, then those disbursements are also startup expenses.
• Startup assets : Typical startup assets are cash (the money in the bank when the company starts), business or plant equipment, office furniture, vehicles, and starting inventory for stores or manufacturers.

A Simple Starting Costs Example

I’ve used a bicycle store as an example in several posts that are part of this series of standard business plan financials. Here’s a visual in spreadsheet form, of sample starting costs for a hypothetical bicycle store.

Notice that the lists for estimating starting costs, on the left in the illustration above, are matched to another list of starting funding, on the right side of the illustration. Books have to balance, so the initial estimates need to include not just the money you spend, but also where it comes from. In the case above, Garrett had to find $124,500, and you can see that he financed it with Accounts Payable, debt, and investment in various categories.

Another Simple Starting Costs Example

Here is another simple example: the starting costs worksheet that Magda developed for the restaurant I used for a sample sales forecast . Magda’s list includes rent and payroll, the same as in her monthly spending, but here they are included in starting costs because these expenses happen before the launch.

I included rent and payroll because they point out the importance in timing. The difference between these as startup expenses and running expenses is timing, and nothing else. Magda could have chosen to plan startup expenses as a running worksheet on expenses, starting a few months before launch, as in the illustration below. The launch in this case is early January, so the expenses for October through December are startup expenses. I prefer the separate lists, because I like the way the two lists create an estimate of starting costs. But that’s an option.

The LivePlan Alternative

If you’re a LivePlan user, the LivePlan interface assumes this method and has a more intuitive interface than the spreadsheet version I’m showing in this post. For LivePlan, you start your plan when you start spending, regardless of launch date. So the spending you do for rent and salaries and such, before launch, is part of the flow, as above. Also, LivePlan has its own guided way of helping you figure out what assets you need, how much they cost, and how you are going to finance starting costs, to set up your balance. And the LivePlan cash flow estimator will help you decide how much cash you need, so you don’t have to follow the spreadsheet method here (below).

How to Estimate Your Starting Costs

Obviously the goal with starting costs isn’t just to track them, but to estimate them ahead of time so you have a better idea, before you start a new business, of what the financial costs might be. Breaking the items down into a practical list makes the educated guess a lot easier. Ideally, you know the business you want to start, you are already familiar with the industry, so you can do a useful estimate for most of the startup costs from your own experience. If you don’t have enough firsthand knowledge, then you should be talking to people who do. For others, such as insurance, legal costs, or graphic design for logos, call some providers or brokers, and talk to partners; educate those guesses.

Starting Cash is the Hardest and Most Important

How much cash do you need in the bank, as you launch? That’s usually the toughest starting cost question. It’s also prone to misinformation, such as those alleged rules of thumb you can find everywhere, saying you need to have a year’s worth of expenses, or six months’ worth, before you start. It’s not that simple. For most businesses, the startup cash isn’t a matter of what’s ideal, or what some expert says is the rule of thumb – it’s how much money you have, can get, and are willing to risk.

The best way is to do a Projected Cash Flow while leaving the supposed starting cash balance at zero, which shows how much (at least in theory, according to assumptions) the startup really needs in cash to support the business as it grows, before it reaches a monthly cash flow break-even point. Magda did that to determine the $12,000 needed as starting cash for her restaurant. Note how, in the illustration here, the lowest point in cash is slightly less than $12,000:

That low point comes, theoretically, in the third month of the business, March. The low point is $11,609. Obviously that’s just an educated guess, but it’s based on assumptions for sales forecast, expense budget, and important cash flow factors including sales on account and purchasing inventory. So it’s better than a stab in the dark, or some rule of thumb. Just as an example, the total spending with the estimates shown here, the theoretical “year’s worth of spending,” is $182,000 (which you don’t see on the illustration, by the way, but take my word for it). The total for the first six months is $93,000. If Magda sticks to those old formulas, she can’t start the business. She is able to raise enough money, between loans and her savings, to put $12,000 into the starting cash balance. So that’s what she does. Then she launches and continues to have her monthly reviews, and watch the performance of all key indicators very carefully.

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What Are Production Costs?

Understanding production costs, special considerations.

• Production Costs FAQs
• Corporate Finance

Production Costs: What They Are and How to Calculate Them

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

Katrina Ávila Munichiello is an experienced editor, writer, fact-checker, and proofreader with more than fourteen years of experience working with print and online publications.

Production costs refer to all of the direct and indirect costs businesses face from manufacturing a product or providing a service. Production costs can include a variety of expenses, such as labor, raw materials , consumable manufacturing supplies, and general overhead .

Key Takeaways

• Production costs refer to the costs a company incurs from manufacturing a product or providing a service that generates revenue for the company.
• Production costs can include a variety of expenses , such as labor, raw materials, consumable manufacturing supplies, and general overhead. 
• Total product costs can be determined by adding together the total direct materials and labor costs as well as the total manufacturing overhead costs. 

Investopedia / Crea Taylor

Production costs, which are also known as product costs, are incurred by a business when it manufactures a product or provides a service. These costs include a variety of expenses. For example, manufacturers have production costs related to the raw materials and labor needed to create the product. Service industries incur production costs related to the labor required to implement the service and any costs of materials involved in delivering the service.

Taxes levied by the government or royalties owed by natural resource-extraction companies are also treated as production costs. Once a product is finished, the company records the product's value as an asset in its financial statements until the product is sold. Recording a finished product as an asset serves to fulfill the company's reporting requirements and inform shareholders .

To qualify as a production cost, an expense must be directly connected to generating revenue for the company.

Total product costs can be determined by adding together the total direct materials and labor costs as well as the total manufacturing overhead costs. Data like the cost of production per unit or the cost to produce one batch of product can help a business set an appropriate sales price for the finished item.

To arrive at the cost of production per unit, production costs are divided by the number of units manufactured in the period covered by those costs. To break even, the sales price must cover the cost per unit. Prices that are greater than the cost per unit result in profits, whereas prices that are less than the cost per unit result in losses.

Types of Production Costs

Production incurs both fixed costs and variable costs . For example, fixed costs for manufacturing an automobile would include equipment as well as workers' salaries. As the rate of production increases, fixed costs remain steady.

Variable costs increase or decrease as production volume changes. Utility expenses are a prime example of a variable cost, as more energy is generally needed as production scales up.

The marginal cost of production refers to the total cost to produce one additional unit. In economic theory, a firm will continue to expand the production of a good until its marginal cost of production is equal to its marginal product ( marginal revenue ). This, in turn, will tend to equal its selling price.

There may be options available to producers if the cost of production exceeds a product's sale price. The first thing they may consider doing is lowering their production costs . If this isn't feasible, they may need to reconsider their pricing structure and marketing strategy to determine if they can justify a price increase or if they can market the product to a new demographic. If neither of these options works, producers may have to suspend their operations or shut down permanently.

Here's a hypothetical example to show how this works using the price of oil. Let's say oil prices dropped to $45 a barrel. If production costs varied between $20 and $50 per barrel, then a cash-negative situation would occur for producers with steep production costs. These companies could choose to stop production until sale prices returned to profitable levels. 

How Are Production Costs Determined?

For an expense to qualify as a production cost it must be directly connected to generating revenue for the company. Manufacturers carry production costs related to the raw materials and labor needed to create their products. Service industries carry production costs related to the labor required to implement and deliver their service. Royalties owed by natural resource-extraction companies also are treated as production costs, as are taxes levied by the government.

How Are Production Costs Calculated?

Production incurs both direct costs and indirect costs. Direct costs for manufacturing an automobile, for example, would be materials like plastic and metal, as well as workers' salaries. Indirect costs would include overhead such as rent and utility expenses. Total product costs can be determined by adding together the total direct materials and labor costs as well as the total manufacturing overhead costs. To determine the product cost per unit of product, divide this sum by the number of units manufactured in the period covered by those costs.

How Does Production Costs Differ From Manufacturing Costs?

Production cost refers to all of the expenses associated with a company conducting its business while manufacturing cost represents only the expenses necessary to make the product. Whereas production costs include both direct and indirect costs of operating a business, manufacturing costs reflect only direct costs.

Corporate Finance Institute. " Cost of Production ."

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How to Write a Business Plan: Step-by-Step Guide + Examples

Noah Parsons

24 min. read

Updated April 17, 2024

Writing a business plan doesn’t have to be complicated. 

In this step-by-step guide, you’ll learn how to write a business plan that’s detailed enough to impress bankers and potential investors, while giving you the tools to start, run, and grow a successful business.

• The basics of business planning

If you’re reading this guide, then you already know why you need a business plan . 

You understand that planning helps you: 

• Raise money
• Grow strategically
• Keep your business on the right track 

As you start to write your plan, it’s useful to zoom out and remember what a business plan is .

At its core, a business plan is an overview of the products and services you sell, and the customers that you sell to. It explains your business strategy: how you’re going to build and grow your business, what your marketing strategy is, and who your competitors are.

Most business plans also include financial forecasts for the future. These set sales goals, budget for expenses, and predict profits and cash flow. 

A good business plan is much more than just a document that you write once and forget about. It’s also a guide that helps you outline and achieve your goals. 

After completing your plan, you can use it as a management tool to track your progress toward your goals. Updating and adjusting your forecasts and budgets as you go is one of the most important steps you can take to run a healthier, smarter business. 

We’ll dive into how to use your plan later in this article.

There are many different types of plans , but we’ll go over the most common type here, which includes everything you need for an investor-ready plan. However, if you’re just starting out and are looking for something simpler—I recommend starting with a one-page business plan . It’s faster and easier to create. 

It’s also the perfect place to start if you’re just figuring out your idea, or need a simple strategic plan to use inside your business.

Dig deeper : How to write a one-page business plan

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• What to include in your business plan

Executive summary

The executive summary is an overview of your business and your plans. It comes first in your plan and is ideally just one to two pages. Most people write it last because it’s a summary of the complete business plan.

Ideally, the executive summary can act as a stand-alone document that covers the highlights of your detailed plan. 

In fact, it’s common for investors to ask only for the executive summary when evaluating your business. If they like what they see in the executive summary, they’ll often follow up with a request for a complete plan, a pitch presentation , or more in-depth financial forecasts .

Your executive summary should include:

• A summary of the problem you are solving
• A description of your product or service
• An overview of your target market
• A brief description of your team
• A summary of your financials
• Your funding requirements (if you are raising money)

Dig Deeper: How to write an effective executive summary

Products and services description

This is where you describe exactly what you’re selling, and how it solves a problem for your target market. The best way to organize this part of your plan is to start by describing the problem that exists for your customers. After that, you can describe how you plan to solve that problem with your product or service. 

This is usually called a problem and solution statement .

To truly showcase the value of your products and services, you need to craft a compelling narrative around your offerings. How will your product or service transform your customers’ lives or jobs? A strong narrative will draw in your readers.

This is also the part of the business plan to discuss any competitive advantages you may have, like specific intellectual property or patents that protect your product. If you have any initial sales, contracts, or other evidence that your product or service is likely to sell, include that information as well. It will show that your idea has traction , which can help convince readers that your plan has a high chance of success.

Market analysis

Your target market is a description of the type of people that you plan to sell to. You might even have multiple target markets, depending on your business. 

A market analysis is the part of your plan where you bring together all of the information you know about your target market. Basically, it’s a thorough description of who your customers are and why they need what you’re selling. You’ll also include information about the growth of your market and your industry .

Try to be as specific as possible when you describe your market. 

Include information such as age, income level, and location—these are what’s called “demographics.” If you can, also describe your market’s interests and habits as they relate to your business—these are “psychographics.” 

Related: Target market examples

Essentially, you want to include any knowledge you have about your customers that is relevant to how your product or service is right for them. With a solid target market, it will be easier to create a sales and marketing plan that will reach your customers. That’s because you know who they are, what they like to do, and the best ways to reach them.

Next, provide any additional information you have about your market. 

What is the size of your market ? Is the market growing or shrinking? Ideally, you’ll want to demonstrate that your market is growing over time, and also explain how your business is positioned to take advantage of any expected changes in your industry.

Dig Deeper: Learn how to write a market analysis

Competitive analysis

Part of defining your business opportunity is determining what your competitive advantage is. To do this effectively, you need to know as much about your competitors as your target customers. 

Every business has some form of competition. If you don’t think you have competitors, then explore what alternatives there are in the market for your product or service. 

For example: In the early years of cars, their main competition was horses. For social media, the early competition was reading books, watching TV, and talking on the phone.

A good competitive analysis fully lays out the competitive landscape and then explains how your business is different. Maybe your products are better made, or cheaper, or your customer service is superior. Maybe your competitive advantage is your location – a wide variety of factors can ultimately give you an advantage.

Dig Deeper: How to write a competitive analysis for your business plan

Marketing and sales plan

The marketing and sales plan covers how you will position your product or service in the market, the marketing channels and messaging you will use, and your sales tactics. 

The best place to start with a marketing plan is with a positioning statement . 

This explains how your business fits into the overall market, and how you will explain the advantages of your product or service to customers. You’ll use the information from your competitive analysis to help you with your positioning. 

For example: You might position your company as the premium, most expensive but the highest quality option in the market. Or your positioning might focus on being locally owned and that shoppers support the local economy by buying your products.

Once you understand your positioning, you’ll bring this together with the information about your target market to create your marketing strategy . 

This is how you plan to communicate your message to potential customers. Depending on who your customers are and how they purchase products like yours, you might use many different strategies, from social media advertising to creating a podcast. Your marketing plan is all about how your customers discover who you are and why they should consider your products and services. 

While your marketing plan is about reaching your customers—your sales plan will describe the actual sales process once a customer has decided that they’re interested in what you have to offer. 

If your business requires salespeople and a long sales process, describe that in this section. If your customers can “self-serve” and just make purchases quickly on your website, describe that process. 

A good sales plan picks up where your marketing plan leaves off. The marketing plan brings customers in the door and the sales plan is how you close the deal.

Together, these specific plans paint a picture of how you will connect with your target audience, and how you will turn them into paying customers.

Dig deeper: What to include in your sales and marketing plan

Business operations

The operations section describes the necessary requirements for your business to run smoothly. It’s where you talk about how your business works and what day-to-day operations look like. 

Depending on how your business is structured, your operations plan may include elements of the business like:

• Supply chain management
• Manufacturing processes
• Equipment and technology
• Distribution

Some businesses distribute their products and reach their customers through large retailers like Amazon.com, Walmart, Target, and grocery store chains. 

These businesses should review how this part of their business works. The plan should discuss the logistics and costs of getting products onto store shelves and any potential hurdles the business may have to overcome.

If your business is much simpler than this, that’s OK. This section of your business plan can be either extremely short or more detailed, depending on the type of business you are building.

For businesses selling services, such as physical therapy or online software, you can use this section to describe the technology you’ll leverage, what goes into your service, and who you will partner with to deliver your services.

Dig Deeper: Learn how to write the operations chapter of your plan

Key milestones and metrics

Although it’s not required to complete your business plan, mapping out key business milestones and the metrics can be incredibly useful for measuring your success.

Good milestones clearly lay out the parameters of the task and set expectations for their execution. You’ll want to include:

• A description of each task
• The proposed due date
• Who is responsible for each task

If you have a budget, you can include projected costs to hit each milestone. You don’t need extensive project planning in this section—just list key milestones you want to hit and when you plan to hit them. This is your overall business roadmap. 

Possible milestones might be:

• Website launch date
• Store or office opening date
• First significant sales
• Break even date
• Business licenses and approvals

You should also discuss the key numbers you will track to determine your success. Some common metrics worth tracking include:

• Conversion rates
• Customer acquisition costs
• Profit per customer
• Repeat purchases

It’s perfectly fine to start with just a few metrics and grow the number you are tracking over time. You also may find that some metrics simply aren’t relevant to your business and can narrow down what you’re tracking.

Dig Deeper: How to use milestones in your business plan

Organization and management team

Investors don’t just look for great ideas—they want to find great teams. Use this chapter to describe your current team and who you need to hire . You should also provide a quick overview of your location and history if you’re already up and running.

Briefly highlight the relevant experiences of each key team member in the company. It’s important to make the case for why yours is the right team to turn an idea into a reality. 

Do they have the right industry experience and background? Have members of the team had entrepreneurial successes before? 

If you still need to hire key team members, that’s OK. Just note those gaps in this section.

Your company overview should also include a summary of your company’s current business structure . The most common business structures include:

• Sole proprietor
• Partnership

Be sure to provide an overview of how the business is owned as well. Does each business partner own an equal portion of the business? How is ownership divided? 

Potential lenders and investors will want to know the structure of the business before they will consider a loan or investment.

Dig Deeper: How to write about your company structure and team

Financial plan

Last, but certainly not least, is your financial plan chapter. 

Entrepreneurs often find this section the most daunting. But, business financials for most startups are less complicated than you think, and a business degree is certainly not required to build a solid financial forecast. 

A typical financial forecast in a business plan includes the following:

• Sales forecast : An estimate of the sales expected over a given period. You’ll break down your forecast into the key revenue streams that you expect to have.
• Expense budget : Your planned spending such as personnel costs , marketing expenses, and taxes.
• Profit & Loss : Brings together your sales and expenses and helps you calculate planned profits.
• Cash Flow : Shows how cash moves into and out of your business. It can predict how much cash you’ll have on hand at any given point in the future.
• Balance Sheet : A list of the assets, liabilities, and equity in your company. In short, it provides an overview of the financial health of your business. 

A strong business plan will include a description of assumptions about the future, and potential risks that could impact the financial plan. Including those will be especially important if you’re writing a business plan to pursue a loan or other investment.

Dig Deeper: How to create financial forecasts and budgets

This is the place for additional data, charts, or other information that supports your plan.

Including an appendix can significantly enhance the credibility of your plan by showing readers that you’ve thoroughly considered the details of your business idea, and are backing your ideas up with solid data.

Just remember that the information in the appendix is meant to be supplementary. Your business plan should stand on its own, even if the reader skips this section.

Dig Deeper : What to include in your business plan appendix

Optional: Business plan cover page

Adding a business plan cover page can make your plan, and by extension your business, seem more professional in the eyes of potential investors, lenders, and partners. It serves as the introduction to your document and provides necessary contact information for stakeholders to reference.

Your cover page should be simple and include:

• Company logo
• Business name
• Value proposition (optional)
• Business plan title
• Completion and/or update date
• Address and contact information
• Confidentiality statement

Just remember, the cover page is optional. If you decide to include it, keep it very simple and only spend a short amount of time putting it together.

Dig Deeper: How to create a business plan cover page

How to use AI to help write your business plan

Generative AI tools such as ChatGPT can speed up the business plan writing process and help you think through concepts like market segmentation and competition. These tools are especially useful for taking ideas that you provide and converting them into polished text for your business plan.

The best way to use AI for your business plan is to leverage it as a collaborator , not a replacement for human creative thinking and ingenuity. 

AI can come up with lots of ideas and act as a brainstorming partner. It’s up to you to filter through those ideas and figure out which ones are realistic enough to resonate with your customers. 

There are pros and cons of using AI to help with your business plan . So, spend some time understanding how it can be most helpful before just outsourcing the job to AI.

Learn more: 10 AI prompts you need to write a business plan

• Writing tips and strategies

To help streamline the business plan writing process, here are a few tips and key questions to answer to make sure you get the most out of your plan and avoid common mistakes .  

Determine why you are writing a business plan

Knowing why you are writing a business plan will determine your approach to your planning project. 

For example: If you are writing a business plan for yourself, or just to use inside your own business , you can probably skip the section about your team and organizational structure. 

If you’re raising money, you’ll want to spend more time explaining why you’re looking to raise the funds and exactly how you will use them.

Regardless of how you intend to use your business plan , think about why you are writing and what you’re trying to get out of the process before you begin.

Keep things concise

Probably the most important tip is to keep your business plan short and simple. There are no prizes for long business plans . The longer your plan is, the less likely people are to read it. 

So focus on trimming things down to the essentials your readers need to know. Skip the extended, wordy descriptions and instead focus on creating a plan that is easy to read —using bullets and short sentences whenever possible.

Have someone review your business plan

Writing a business plan in a vacuum is never a good idea. Sometimes it’s helpful to zoom out and check if your plan makes sense to someone else. You also want to make sure that it’s easy to read and understand.

Don’t wait until your plan is “done” to get a second look. Start sharing your plan early, and find out from readers what questions your plan leaves unanswered. This early review cycle will help you spot shortcomings in your plan and address them quickly, rather than finding out about them right before you present your plan to a lender or investor.

If you need a more detailed review, you may want to explore hiring a professional plan writer to thoroughly examine it.

Use a free business plan template and business plan examples to get started

Knowing what information to include in a business plan is sometimes not quite enough. If you’re struggling to get started or need additional guidance, it may be worth using a business plan template. 

There are plenty of great options available (we’ve rounded up our 8 favorites to streamline your search).

But, if you’re looking for a free downloadable business plan template , you can get one right now; download the template used by more than 1 million businesses. 

Or, if you just want to see what a completed business plan looks like, check out our library of over 550 free business plan examples . 

We even have a growing list of industry business planning guides with tips for what to focus on depending on your business type.

Common pitfalls and how to avoid them

It’s easy to make mistakes when you’re writing your business plan. Some entrepreneurs get sucked into the writing and research process, and don’t focus enough on actually getting their business started. 

Here are a few common mistakes and how to avoid them:

Not talking to your customers : This is one of the most common mistakes. It’s easy to assume that your product or service is something that people want. Before you invest too much in your business and too much in the planning process, make sure you talk to your prospective customers and have a good understanding of their needs.

• Overly optimistic sales and profit forecasts: By nature, entrepreneurs are optimistic about the future. But it’s good to temper that optimism a little when you’re planning, and make sure your forecasts are grounded in reality. 
• Spending too much time planning: Yes, planning is crucial. But you also need to get out and talk to customers, build prototypes of your product and figure out if there’s a market for your idea. Make sure to balance planning with building.
• Not revising the plan: Planning is useful, but nothing ever goes exactly as planned. As you learn more about what’s working and what’s not—revise your plan, your budgets, and your revenue forecast. Doing so will provide a more realistic picture of where your business is going, and what your financial needs will be moving forward.
• Not using the plan to manage your business: A good business plan is a management tool. Don’t just write it and put it on the shelf to collect dust – use it to track your progress and help you reach your goals.
• Presenting your business plan

The planning process forces you to think through every aspect of your business and answer questions that you may not have thought of. That’s the real benefit of writing a business plan – the knowledge you gain about your business that you may not have been able to discover otherwise.

With all of this knowledge, you’re well prepared to convert your business plan into a pitch presentation to present your ideas. 

A pitch presentation is a summary of your plan, just hitting the highlights and key points. It’s the best way to present your business plan to investors and team members.

Dig Deeper: Learn what key slides should be included in your pitch deck

Use your business plan to manage your business

One of the biggest benefits of planning is that it gives you a tool to manage your business better. With a revenue forecast, expense budget, and projected cash flow, you know your targets and where you are headed.

And yet, nothing ever goes exactly as planned – it’s the nature of business.

That’s where using your plan as a management tool comes in. The key to leveraging it for your business is to review it periodically and compare your forecasts and projections to your actual results.

Start by setting up a regular time to review the plan – a monthly review is a good starting point. During this review, answer questions like:

• Did you meet your sales goals?
• Is spending following your budget?
• Has anything gone differently than what you expected?

Now that you see whether you’re meeting your goals or are off track, you can make adjustments and set new targets. 

Maybe you’re exceeding your sales goals and should set new, more aggressive goals. In that case, maybe you should also explore more spending or hiring more employees. 

Or maybe expenses are rising faster than you projected. If that’s the case, you would need to look at where you can cut costs.

A plan, and a method for comparing your plan to your actual results , is the tool you need to steer your business toward success.

Learn More: How to run a regular plan review

Free business plan templates and examples

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How to write a business plan FAQ

What is a business plan?

A document that describes your business , the products and services you sell, and the customers that you sell to. It explains your business strategy, how you’re going to build and grow your business, what your marketing strategy is, and who your competitors are.

What are the benefits of a business plan?

A business plan helps you understand where you want to go with your business and what it will take to get there. It reduces your overall risk, helps you uncover your business’s potential, attracts investors, and identifies areas for growth.

Having a business plan ultimately makes you more confident as a business owner and more likely to succeed for a longer period of time.

What are the 7 steps of a business plan?

The seven steps to writing a business plan include:

• Write a brief executive summary
• Describe your products and services.
• Conduct market research and compile data into a cohesive market analysis.
• Describe your marketing and sales strategy.
• Outline your organizational structure and management team.
• Develop financial projections for sales, revenue, and cash flow.
• Add any additional documents to your appendix.

What are the 5 most common business plan mistakes?

There are plenty of mistakes that can be made when writing a business plan. However, these are the 5 most common that you should do your best to avoid:

• 1. Not taking the planning process seriously.
• Having unrealistic financial projections or incomplete financial information.
• Inconsistent information or simple mistakes.
• Failing to establish a sound business model.
• Not having a defined purpose for your business plan.

What questions should be answered in a business plan?

Writing a business plan is all about asking yourself questions about your business and being able to answer them through the planning process. You’ll likely be asking dozens and dozens of questions for each section of your plan.

However, these are the key questions you should ask and answer with your business plan:

• How will your business make money?
• Is there a need for your product or service?
• Who are your customers?
• How are you different from the competition?
• How will you reach your customers?
• How will you measure success?

How long should a business plan be?

The length of your business plan fully depends on what you intend to do with it. From the SBA and traditional lender point of view, a business plan needs to be whatever length necessary to fully explain your business. This means that you prove the viability of your business, show that you understand the market, and have a detailed strategy in place.

If you intend to use your business plan for internal management purposes, you don’t necessarily need a full 25-50 page business plan. Instead, you can start with a one-page plan to get all of the necessary information in place.

What are the different types of business plans?

While all business plans cover similar categories, the style and function fully depend on how you intend to use your plan. Here are a few common business plan types worth considering.

Traditional business plan: The tried-and-true traditional business plan is a formal document meant to be used when applying for funding or pitching to investors. This type of business plan follows the outline above and can be anywhere from 10-50 pages depending on the amount of detail included, the complexity of your business, and what you include in your appendix.

Business model canvas: The business model canvas is a one-page template designed to demystify the business planning process. It removes the need for a traditional, copy-heavy business plan, in favor of a single-page outline that can help you and outside parties better explore your business idea.

One-page business plan: This format is a simplified version of the traditional plan that focuses on the core aspects of your business. You’ll typically stick with bullet points and single sentences. It’s most useful for those exploring ideas, needing to validate their business model, or who need an internal plan to help them run and manage their business.

Lean Plan: The Lean Plan is less of a specific document type and more of a methodology. It takes the simplicity and styling of the one-page business plan and turns it into a process for you to continuously plan, test, review, refine, and take action based on performance. It’s faster, keeps your plan concise, and ensures that your plan is always up-to-date.

What’s the difference between a business plan and a strategic plan?

A business plan covers the “who” and “what” of your business. It explains what your business is doing right now and how it functions. The strategic plan explores long-term goals and explains “how” the business will get there. It encourages you to look more intently toward the future and how you will achieve your vision.

However, when approached correctly, your business plan can actually function as a strategic plan as well. If kept lean, you can define your business, outline strategic steps, and track ongoing operations all with a single plan.

See why 1.2 million entrepreneurs have written their business plans with LivePlan

Noah is the COO at Palo Alto Software, makers of the online business plan app LivePlan. He started his career at Yahoo! and then helped start the user review site Epinions.com. From there he started a software distribution business in the UK before coming to Palo Alto Software to run the marketing and product teams.

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Home > Financial Projections > Cost Structure in a Business Plan

Cost Structure in a Business Plan

What is cost structure.

Financial projections need to take account of the cost structure of a business. Cost structure simply refers to the split between variable costs and fixed costs, but can have a significant impact on whether a new start up business is successful or not.

Fixed and Variable Costs

First a few definitions. A variable cost is a cost which changes in direct proportion to any production or selling activity, examples include, direct materials and labor used in manufacture, product cost, and sales commissions. On the other hand, a fixed cost is a cost which will occur whether or not a business has any production or selling activity. Fixed costs are a function of the passage of time, examples include rent, salaries, and insurance.

Low Fixed Cost Structure or High Fixed Cost Structure?

Although the cost structure of a business is to some extent fixed by the nature of the business and the type of industry in which it operates, decisions can be taken to directly influence the split between fixed and variable costs. It is important to understand that a business can have the same sales, total costs and therefore profit, but a completely different costs structure, as seen in the diagrams below.

Both businesses have the same sales, total costs, and profit, however, the first business has a high fixed cost structure compared to the low fixed cost structure of the second business.

Business Plan Cost Structure and Break Even

Consider as an example the two start up businesses shown in the table below. The financial projections of the first business show a high fixed cost structure. the business plans to start by investing heavily in production facilities, machinery and equipment to manufacture and distribute its own product. The consequence of this decision is high fixed costs but lower variable costs.

The second business proposes a lean start up. It plans to have the manufacture and distribution outsourced to a third party, its needs smaller premises and less investment in machinery and equipment and therefore has lower fixed costs but correspondingly higher variable costs, as payments need to be made to the third parties for manufacture and distribution.

Effect of Cost Structure on Break Even Calculations

In each case, the number of units sold (6,000), selling price (12,00), total costs (65,000), and profits (7,000) are identical. Using this information and the break even formula, the break even point can be calculated for each of the start up businesses.

The break even formula is:

and the break even units are given by the formula:

The results of the calculations using the formulas are summarized in the table below.

We can see that even though everything else is the same, the financial structure of the business has resulted in a completely different break even position.

For the low fixed cost structure business, only 3,083 units need to be sold at 12.00 to reach break even as shown in the diagram below.

In contrast for the high fixed cost business 5,028 units need to be sold to reach break even as indicated in the diagram below.

In order to break even, the high fixed cost business needs to sell 1,945 (63%) more units than the low fixed cost business.

The conclusion is that when producing financial projections for a start up business, in order to reduce the break even point to an acceptable level, the cost structure should aim to keep the fixed costs as low as possible.

About the Author

Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.

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How to describe your product and service in a business plan like a pro

It’s deceiving.

You’d think that this part of a business plan does exactly what it says on the tin–describe your product & service offering– right ?

And yes, you are partially right. 

But there’s a very specific way in which this description should be written to make sure that your business has the best chance of succeeding – in real life and under the eagle eye of a potential backer (if you’re preparing a business plan for external financing purposes).

Keep reading to find out the secret sauce to writing a winning product and service description:

WHAT is the Product and Service Description in a Business Plan?

This business plan section is also known as:

• Product and/or Service Overview

HOW Do You Write a Product and Service Description in a Business Plan?

So, what should a good product/service overview contain?

Here are some items to consider including into this section:

1.     Portfolio:

The range of products and/or services that a business offers to potential and current customers.

2.     Features and benefits (value proposition):

Explain what the product/service does and how it works.

3.     Problem and solution (value proposition cont.):

The problem(s) the product or service solves. Every business needs to solve a problem that its customers face. Explain what the problem is and how the product or service solves it.

4.     Innovation:

If the company is doing something new and different, explain why the world needs the innovation.

5.     Proprietary advantages:

Any proprietary features that contribute to a competitive advantage. This could include: intellectual property (e.g., copyright, trademark, patent filings, trade secret), exclusive agreements with suppliers or vendors, exclusive licenses (e.g., for a product, service or technology), company’s own research and development activities.

6.     Development stage:

Current stage of development of the product / service (e.g., idea, development, testing, prototype, already on the market).

7.     Product life-cycle:

Estimate the life span of the product or service.

Specify whether the product or service under consideration is a short-lived fad or has a long-term potential.

8.     Future:

Mention plans for changes and new additions to the current portfolio of products / services.

Describe any plans to move into new markets in the future (e.g., serving different types or sizes of customers, industries, geographic areas).

Make your best guess at when the business will be ready to address these markets and what it needs to do first to be ready.

9.     Limitations:

If applicable, explain any risks or limitations associated with the product (e.g., liability issues like guarantees or returns), along with any legal advice received regarding these issues.

10.  Visual aids:

Use photos, images, diagrams and other graphics to help the reader visualize and learn about the products / services.

If the business is tackling several distinct problems through different products / services, describe the solutions individually .

However, for a large line of products / services, there is no need to list each one, just identifying the general categories will suffice.

How LONG Is the Product and Service Chapter of a Business Plan?

This part of a business plan can be very short, just a couple of paragraphs, or it can spread over multiple pages, depending on how many products/services you offer and how much explanation they require.

If your products or services are particularly complex , technical , innovative , or proprietary , you will want to provide more information and spend considerable time describing them.

This is especially true if you are seeking funding for a new product or service, particularly one that is not immediately understandable to the business plan readers, and if potential funders are likely to be motivated by the specifics.

In any case, when describing a product or service, provide just enough information to paint a clear picture of what it is and does . A brief explanation of what you will be making, selling or doing is appropriate here.

Excessive detail makes this section cumbersome for a reader to wade through. Reserve detailed descriptions (e.g., production processes) for the Appendix.

In any case, it is a good idea to first summarize the value proposition of each product or service into a one short sentence, and only then continue with a more detailed description of the product or service.

If any images or graphics are available that would contribute to the understanding of the product or service, the writers of a business plan should use them.

Otherwise, include any product or service details , such as technical specifications, drawings, photos, patent documents and other support information, in the Appendix section of the business plan document.

TOP 4 TIPS for Writing a Product and Service Overview

Tip #1: features v. benefits.

Don’t just list the features of the product / service.

Instead, describe the specific benefits it will offer to customers – from their perspective.

Make it clear what your customers will gain through buying your product or service. Include information about the specific benefits of your product or service – from your customers’ perspective.

Features are not the same thing as benefits. And you need to understand both.

Confused? Let’s clarify:

What Is the Difference Between Features and Benefits?

Tip #2: problem v. solution.

If at all possible, present the information in the Problem >> Solution format.

Start by describing the key problem that your customers have, immediately followed by the solution with which you will address this need for your target market.

Tip #3: Competitive Advantage

You should also comment on your ability to meet consumers’ key problems or unmet needs in a way that brings your product or service advantages over the competition.

For example:

• If you have a common business, such as a restaurant:

Explain why your customers need your particular restaurant. Do you offer lower prices? More convenient hours? A better location? A different concept, such as a vegan ice-cream pop up store? A specialty that is not otherwise available in your area, such as a Peruvian ceviche or Hungarian goulash?

• If your company is doing something new and innovative :

What is it about the existing solutions that is subpar? Maybe you are improving on a mediocre product category, such as creating better medical uniforms for healthcare workers (e.g., more flattering cut, trendy designs, sustainable materials). Or perhaps your new blockchain solution has the potential to entirely eliminate the middle-men in an entire industry.

Although the subject of competitive advantage regarding the business as a whole will be fully explored in the Market and Competitor Analysis part of a business plan, it is advisable to touch on it here also – in the context of the company’s products and service.

Tip #4: Validating the Problem and Solution

Speaking of which, when you are doing market research and analysis for your business plan, remember to validate the problem and solution your product or service is addressing.

There is a plethora of minor issues out there that people are perfectly fine with just tolerating. To build a solid business, though, you need a problem that a sufficient number of people are motivated to solve. That is, that they recognize it as a problem that’s worth paying you to solve. Even if they didn’t realize it was solvable until they were presented with your solution.

So, how do you get evidence that prospects are willing to pay for your solution?

Validation of Problem

Describe what you’ve done so far to confirm that the problem you are focused on is a real problem for your customers.

• Existing Business:

For an established business, this is probably just a matter of recapping your success in the marketplace. Your customers have already voted with their wallets.

• New Business:

For a startup, it is important to survey and have conversations with as many potential customers as possible about where they are having problems, how they solve them today, and validate that they are interested enough in addressing those problems to pay for a good solution.

Validation of Solution

Describe how you have tested your ideas with existing or potential customers to confirm that there is a good market for the products or services you plan to offer. Summarize the positive customer feedback or market traction that you have achieved with your solution so far.

For an established business, the answers probably lie in your paying customer base – their existence itself, combined with their repeat business, word-of-mouth referrals, follow-up customer surveys, and other indicators of customer satisfaction.

For a new business, you can start validating your solution immediately by trying it out with potential customers, even informally or at no charge, to get their opinion. If your product or service does not exist yet, talk to prospects about what you plan to offer and measure their feedback.

In summary, this section should answer the million dollar question:

What makes you think that people will buy, be satisfied with, and recommend your products or services?

Related Questions

What are products and services.

Products and services are items that businesses offer for sale to a market. While services are intangible, meaning that they do not exist in a physical form, products are of tangible nature, in other words – you can touch them.

What is a Product Line?

Product line is a group of related products that are all produced or sold by one entity and typically marketed under one brand name.

What is a Service Line?

Service line is a group of related services that are all produced or sold by one entity and typically marketed under one brand name.

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Business process for product costing and how it relates to other processes with Dynamics 365

• 3 contributors

Applies to: Dynamics 365 Business Central, Dynamics 365 Commerce, Dynamics 365 Field Service, Dynamics 365 Finance, Dynamics 365 Project Operations, Dynamics 365 Sales, Dynamics 365 Supply Chain Management, Microsoft Supply Chain Center

This article describes the business process for defining the cost of products. It also explains how that process relates to other business processes in Dynamics 365.

The definition of product costs is essential for any organization that wants to understand and effectively manage its finances. The goal is to know the amount of money that goes into producing or purchasing a particular item, and the cost of delivering that item to the customer. This information is crucial for setting prices, making informed decisions about resource allocation, and evaluating the financial performance of the business.

Here are some of the key reasons why the definition of product costs is important:

• Pricing : An understanding of the costs of a product helps organizations set prices that are appropriate and profitable. If the costs aren't understood, it can be difficult to determine a fair price that covers expenses and generates a profit.
• Profitability : By calculating the costs that are associated with producing or purchasing products, organizations can determine whether they are making a profit. This information is crucial for assessing the financial health of the business and identifying areas for improvements.
• Resource allocation : An understanding of the costs of producing products helps organizations more effectively allocate their resources. By understanding the costs that are involved, businesses can make decisions about how to allocate resources such as labor, materials, and equipment.
• Cost reduction : An understanding of the costs of producing products can help organizations identify areas where costs can be reduced. If expenses can be reduced in any areas without compromising quality, businesses can become more efficient and improve their bottom line.

Overall, the definition of product costs is essential for any organization that wants to operate efficiently, remain competitive, and generate a healthy profit. By having a clear understanding of costs, businesses can make informed decisions about pricing, resource allocation, and cost reduction. Therefore, they can ultimately achieve greater success and profitability.

Dynamics 365 includes tools to help support organizations define product costs to track, report, and analyze profitability, margins, and more. Here are just a few examples that show how Dynamics 365 can support your costing business requirements:

• Dynamics 365 Sales and Field Service include product catalogs , so that you can quickly define the product cost that is tracked on each transaction.
• Dynamics 365 Supply Chain Management includes robust cost calculation features, such as bill of materials (BOM) and formula cost roll-ups or calculations for produced items. Learn more at Cost management home page .
• Dynamics 365 Supply Chain Management also supports the calculation of indirect costs (sometimes referred to as overhead costs) for purchased or produced items. In addition, it supports a costing sheet that you can use to analyze the breakdown of costs.
• The Transportation management module in Dynamics 365 Supply Chain Management helps you calculate your inbound and outbound freight and handling costs. Learn more at Transportation management overview .
• Dynamics 365 Business Central includes cost accounting to help you understand the costs of running a business. Learn more at Cost accounting overview .
• Dynamics 365 Business Central also includes inventory costs , so that you can report on manufacturing costs and inventory costs (that is, the value of items). Learn more at Manage inventory costs .

Stakeholders

There are several stakeholders in an organization that should be involved in defining product costs, because the process can have a significant impact on the overall success of the business. Here are some of the stakeholders who should be involved:

• Finance and accounting teams : The finance and accounting teams are responsible for managing the financial health of the organization. They should be involved in defining product costs because they have the expertise to analyze costs and identify areas where expenses can be reduced.
• Operations teams : The operations teams are responsible for producing, procuring, and delivering products. In project-based organizations, these teams include project management teams. These teams might also include the transportation teams that are responsible for sourcing inbound and outbound transportation. These teams should be involved in defining product costs because they have first-hand knowledge of the processes and resources that are required to procure, produce, and deliver the products.
• Sales and marketing teams : The sales and marketing teams are responsible for pricing products and promoting them to customers. They should be involved in defining product costs because they must understand the costs that are associated with the products, so that they can set prices and develop marketing strategies.
• Senior management : Members of senior management should be involved in defining product costs because they are responsible for making strategic decisions that affect the overall direction of the organization. They must understand the costs that are associated with products, so that they can make informed decisions about resource allocation and pricing strategies.
• Customers : Although customers aren't directly involved in defining product costs, they are important stakeholders who can provide valuable feedback about pricing and product quality. An understanding of the costs that are associated with products can help organizations make pricing decisions that are fair and competitive, but also meet the needs of their customers.

Overall, when product costs are defined, it's important to involve all stakeholders who have a vested interest in the success of the organization. By working together to analyze costs and identify areas for improvement, organizations can make informed decisions that drive growth and profitability.

Define product costing process flow

The following diagram illustrates the define product costing business process area. Each solid gray rectangle on the diagram represents an end-to-end business process. The solid blue rectangle represents the business process area. The diagram shows the subprocesses for the business process area. The arrows on the diagram show the flow of the business process in an organization. If a subprocess can lead to more than one other subprocess, the parallel subprocesses are shown as branches.

Parallel branches connect to the Plan to produce and Procure to pay end-to-end processes, each of which connects to d. Analyze product costing strategy .

Design to retire

A parallel branch connects to Introduce new products , which also connects to 3. Define product costing .

Define product costing

Define product costing strategy

A parallel branch connects to Manage product pricing , which connects to Order to cash .

Set costing standards

Parallel branches connect to Order to cash , Plan to produce , Procure to pay , and Inventory to deliver .

Maintain costing standards

Parallel branches connect to Plan to produce , Procure to pay , and Inventory to deliver .

Analyze product costing strategy

Record to report

Each of the following end-to-end processes connects to the Record to report box:

• Order to cash
• Plan to produce
• Procure to pay
• Inventory to deliver

Define product costing benefits

There are many key benefits that can be used to monitor and measure the success of implementing technology to support the define product costing processes. The following sections outline the key benefits that an organization might monitor and measure for define product costing .

Accurate costing

Dynamics 365 includes powerful tools for accurately calculating product costs based on actual expenses, such as materials, labor, and overhead. For example, Dynamics 365 Supply Chain Management includes robust cost calculation features such as BOM and formula cost roll-ups or calculations for produced items, and the ability to calculate indirect costs or overhead costs for purchased or produced items.

Real-time and flexible cost information

Dynamics 365 provides real-time cost information, so that organizations can track costs as they change and adjust pricing and resource allocation accordingly. For example, Dynamics 365 Sales and Field Service includes a product catalog feature that helps you quickly define the product cost that is tracked on each transaction. By using the Global Inventory Accounting add-in with Dynamics 365 Supply Chain Management, organizations can analyze costs in multiple currencies or costing methodologies, for example.

Streamlined processes

Dynamics 365 streamlines the product costing process by automating many of the manual tasks that are involved in cost calculation and analysis. For example, Dynamics 365 Supply Chain Management includes a costing sheet that you can use to analyze the breakdown of costs.

Improved collaboration

By using Dynamics 365 together with Microsoft Teams and Microsoft 365, you get a centralized platform that supports collaboration among the various teams that are involved in the product costing process, including finance, operations, and sales. This collaboration improves communication and visibility, and therefore leads to better decision-making and more informed cost calculations.

Enhanced reporting and analysis

Dynamics 365 provides advanced reporting and analytics capabilities that are built with Power BI and the Azure Data Lake. Organizations can use these capabilities to gain insights into their cost structures and identify areas for improvement. For example, you can use the Transportation management module in Dynamics 365 Supply Chain Management to calculate your inbound and outbound freight and handling costs.

If you want to implement Dynamics 365 solutions to assist with your product costing business processes, you can use the following resources and steps to learn more.

Define product catalog and strategy

Introduce new products

Define product costing (the article that you're currently reading)

Define product pricing

Manage product lifecycle

Related resources

You can use the following resources to learn more about the product costing process in Dynamics 365.

Cost management home page

Cost accounting home page

Work with the costing sheet in Dynamics 365 Supply Chain Management

Get started with cost accounting in Dynamics 365 Finance

Get started with cost accounting for supply chains in Dynamics 365 Finance

Use cost accounting in Microsoft Dynamics 365 Business Central

Cost Accounting Series - Dynamics 365 Supply Chain Management TechTalk Series

Inventory Costing in Dynamics 365 Supply Chain Management TechTalk Series

Design Details: Costing Methods in Dynamics 365 Business Central

Cost accounting in Business Central

Inventory costs in Business Central

Issue and settle vendor payments overview

Find definitions of terminology that is used in content for define product costing in the Glossary of terms in Dynamics 365 business processes article. For example, this glossary includes the following terms:

• Cost accounting
• Costing methodology
• Costing sheet
• Costing version
• Overhead costs

Contributors

This article is maintained by Microsoft. It was originally written by the following contributors.

Principal author:

• Rachel Profitt | Microsoft FastTrack Solution Architect

Other contributors:

• Michael Herold | Microsoft Principal Consultant

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