Costing Methodologies

September 2, 2010, 12:00 am

Small Business Finance & Profitability

By William Stong

There is a continuum of costing methodologies. They range from “None” to frequently updated costing that is integrated with the daily business processes of a company. The continuum goes from “Simplest” to “Most Complex”; from “Least Detail” to “Most Detail”; from “Minimal Insight” to “Strategic & Tactical business-decisioning Insight.”

Here’s one way to view the possibilities:

Do nothing

● Do not spend time on costing work; rather, rely on intrinsic understanding of and familiarity with the business’ revenue, activities, and expenses

● This option works best when the business is simple, monolithic, and small

Use the general ledger reporting

a) As is reporting

● Use general ledger reporting as it comes off the presses: the financial reports automatically calculate net profit

● This option works best when the business consists of one, basically undifferentiated product line

b) With business-relevant normalizations

● Modify the general ledger numbers to remove financial impacts which have nothing to do with normal, ongoing core business activities

Do “Back of the Envelope” analysis

● Spend time dividing the company’s general ledger into the product and services to be costed. Use the 100% Rule to fully allocate all general ledger accounting lines.

● This option is best used when you need a quick, basic understanding of your company’s business by product, service, or other categorizations (e.g., customer segments; service tiers)

● Depending on the needs of the company, Back of the Envelope studies may be:

a) done one time

b) periodically updated

Implement a formal costing methodology

● Invest in one of the formal costing methodologies (see below for further resources) which, while requiring dedicated and skilled resources, also provides the most comprehensive, insightful, and business-decision actionable results.

● Once a costing process is in place, a company is faced with how to maintain the cost numbers. Several inputs to costing continually change:

- New products & services are created; some are retired

- Operational procedures and processing steps change

- Financial numbers change (every month)

- Volume of customer transactions change (every month)

● Here are a few ways a company could proceed:

a) Conduct a one-time costing effort

b) Periodically refresh the cost numbers (i.e., update with current expense dollars and transaction volumes)

c) Periodically re-do the costing (i.e., in addition to the dollar and volume update, re-calculate the detailed components of the costing process, including current products and services)

d) Integrate with ongoing company processes: basically, automating the process and embedding in how the company manages its business

If you are interested in delving more into costing for your company, here are some pertinent websites:

● bnet: The CBS Interactive Business Network

● Ezine @rticles

● Accounting Coach

● Wikipedia: Cost Accounting

Alternatively, contact me and we can talk about what would make the most sense for your particular business and situation.

Bill

William A. Stong

Email: william.a.stong@gmail.com

SBF&P # 78

Telephone: 925-202-6244