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COSTING: THE IMPORTANT PART OF STANDARD COSTS IN THE "MANAGEMENT" AND "PRICING" PROCESSES


添加日期 → March 26, 2019


COSTING: THE IMPORTANT PART OF STANDARD COSTS IN THE "MANAGEMENT" AND "PRICING" PROCESSES

The growing competitive level reached in all markets, along with a lot of new players, that are able to produce with much more competitive costs, created what we can define as expenses accounting. Above all we can use it for pricing strategies: today no businessman can ever deny that only a deep knowledge of his own expenses structure could really allow him to build strong pricing policies.

 

There are two approaches to use in order to define the market price of your product:

  • using the method of cost plus pricing: where you fix a product cost and you charge it with an extra mark up, in order to create the final sales price.
  • Or with the so called target pricing: through this method you compete with your main competitors in order to set a target price that you deem it is the right one for the market, or a price received from the agent, sales man or customer. Using this price you define the minimum expected profit to find the maximum cost of your production. This will be compared  with how your company really works, in order to check if the current structure allows you to produce your goods using that target cost and hence sell at the requested price.

Actually, the distinction between these two approaches is more theoretical than objective: it is unlikely to think about the use of cost plus pricing without making a confrontation with the current market situation. Equally, it is not possible to think about a target costing approach, without taking into account the company’s real structure.

Both the approaches can be  reanalysed in NOW and all the conclusions drawn can be compared and overlapped.

The starting point of the above process, is based  on  the definition of the product’s cost, established considering all the company’s expenses: in other words, using the so called full costing approach.

It is the total sum of all expenses faced in order to sell the final product to the market.

So, we can define the direct costs meaning all those that may directly be attributed to the product, through an objective measuring of the input’s consumption. On the other hand we have the indirect costs, that can not be directly charged to a single product, but they should be allocated using proper and different methods.

The expenses incurred by a company can be classified using the approach of cost’s level. They start from the more direct ones, that is all the closest to the final product, to the indirect ones, which are the farthest from the “real product”.

The three costs’ levels are:

  • Direct Costs’s limit
  • Warehouse Costs’ edge
  • Full Cost

In NOW all the Cost’s Components can be traced back to a cost level.

In Picture 1  we can see a type of Cost’s Components codification, which leads to the definition of a Full Cost. In this example we can also see the example of a Cost’s Level hierarchy and the definition used to compute the Cost Component one-off, only for the Final Product which has been created to be sold to the market. 

picture 1 

Since the Full Costing Method is based on the assumption that all costs should be somehow attributed to finished products, it is important to allocate all the costs; the direct and also the indirect ones.

 

Usually, all the raw material’s costs are assigned to each product according to the amount of material used to create the actual product and related to their real purchase price; the packaging material is assigned to  the goods which have been actually shipped….and so on.

 

Therefore, in NOW all the costs are pre-set using an “Internal Price List”, which should assign to an hypothetic cost all the purchased  material. Surely, we can not foresee what happens in the future, so we can not claim that ”.. we will spend this money to buy the raw material..”. We could just establish a  value, based on the real costs of the past period immediately preceding the present day, on the analysis of the market trends and  on the business relationships with our suppliers.

This value is known as the Internal Price List (picture 2)

picture 2

Although, there are also direct costs which should not be allocated  using a simple relationship between all the costs incurred and the amount of the items produced. We should actually use other criteria, such as the machine / time consumption (pic. 1, point 2), as it is easily detectable in each of the stages involved in the production chain. This approach can be found in all the important and immediately visible resources, such as “labour” or “electric energy”.

You can find below in pic.3 an example of Internal price list.

picture 3

You can find in the next newsletter the second part of the analysis, concerning the indirect costs and other simulations linked to sales orders.

 

 

 













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