COSTS ???

Every business has costs. Costs are the money your business spends to make and sell your goods or services.

COSTING

Costing is the calculation of all of the costs that go into making and selling a good or providing a service.

TYPES OF COSTS

Costs of a business can be broadly classified into two categories based on their sources: Production and
NonProduction Costs. Separating Production Costs from Non-Production Costs helps businesses find a true
picture of the costs to make a good or provide a service.
Production Costs are those that are incurred in the production of your goods or the provision of your services.
Raw materials, packaging and workers’ wages are examples of Production Costs. These costs often fluctuate with
production volume, sales volume or service provision.
Non-Production Costs are all other costs, except Production Costs, that you have in order to run your business.
For example, rent, utilities and salaries for administrative functions are all Non-Production Costs. These costs do
not fluctuate in direct proportion to the number of products being produced or sold and tend to remain constant
over a given period of time. Non-Production Costs are generally called Overhead Expenses.

Production Costs

Production Costs can be divided into two different types:

• Material Costs
• Labour Costs

Production Costs

Material Costs Labour Costs

Material Costs are the money your business spends on the parts and materials that are related to the production
of your goods or provision of your services. Labour Costs are the amount your business spends on wages, salaries
and benefits for the employees and owners who work in the production of your goods or the provision of your
services.

Non-Production Costs

In addition to Production Costs, all businesses also have costs for running the business. These costs are Non-
Production Costs or Overhead Expenses.
 All costs that not related to the production process are Overhead Expenses. Costs for buildings, rent, electricity,
water, maintenance, repairs, service, insurance, stationery, licences, interest on loans and other financial services
fees are some examples of Overhead Expenses.

The transport of materials or goods, visiting suppliers or customers and delivering goods to customers are all
Overhead Expenses. The cost of wages for employees or owners who do not work directly in the production of goods
or services is an Overhead Expense. Some other examples of salaries that are Overhead Expenses are those for
accountant, sales staff, messengers, cleaners and security guards.

Equipment is all the machinery, tools, workshop fittings, office furniture, etc. that a business needs Equipment loses
value every year and is a cost to the business, so this is an Overhead Expense. The loss in value of equipment is
called depreciation. Depreciation is calculated by dividing the total purchase price by the number of years (or
months) you expect to use it.

Total purchase price

Depreciation =
Number of years (or months) to be used

For example, your business buys a desktop computer. The cost of the purchase is $600 and you expect to use it for
five years. The cost of using the computer for one year (or yearly depreciation) will be:

$600
Yearly depreciation = = $120
5

To estimate how long you expect to use your equipment, you can:

• Base the estimate on your own experience

• Ask suppliers
• Ask the owners of other businesses using the same or similar equipment

For some businesses, particularly those in manufacturing, depreciation costs are high. Therefore, it is important to
include depreciation costs when calculating the cost of your goods.

If you are a retailer or wholesaler, all your costs, except the costs of buying goods to resell, are Overhead Expenses.
Now you can see that there are different types of costs that make up the total cost of a good or service.

Overhead
Material Costs + Labour Costs + = TOTAL COST
Expenses

You need to know about all the different costs in your business to be able to do an accurate costing. You must decide:

• Which are Material Costs?

• Which are Labour Costs?
• Which are Overhead Expenses?

HOW CAN C0STING IMPROVE YOUR BUSINESS

 • Costing helps you to set prices.
To sell your goods or services, you have to set competitive prices. To ensure the sales of your goods or services is
profitable, you must set prices that are higher than the cost to produce the goods or services. When you know
all of your costs, you can set the appropriate price for your good or service to make your business profitable.

• Costing helps you to reduce and control your costs.

Knowing all your costs helps you to find ways to make your business more cost-efficient.

• Costing helps you to make better decisions about your business.

When you know the total cost of each type of good or service, you can make more informed decisions about which
goods or services to produce or promote most heavily so that your business makes the highest profit.

• Costing helps you to plan for the future.

When you know all your costs, you can make plans for the direction of your future business. For example, you
need to know all your costs in order to make an accurate Sales and Marketing Plan, a Production and Cost Plan
or a Cash Flow Plan.

In order to calculate Production Cost for each particular product, multiple product manufacturers or service operators
divide their Production Costs into three groups: Direct Material Costs, Direct Labour Costs and Indirect Manufacturing
Expenses.
Direct Material Costs are all the Material Costs that are:

• Easy to trace to a particular good or service.

• A substantial enough cost that adds a considerable amount to the total cost. A cost will be considered substantial
if the time and effort involved allocating it to a particular good or service would be worth the benefit of accurate
cost allocation.
Direct Labour Costs are all the Labour Costs that are:

• Easy to trace to a particular good or service.

• A substantial enough cost that adds a considerable amount to the total cost
Indirect Manufacturing Expense is the amount of money a business spends on the materials or labour related to the
production of goods or services, but that cannot be considered as Direct Labour Cost or Direct Material Cost. In other
words, Indirect Manufacturing Expenses include all Production Costs which are either difficult to trace to a particular
product or insubstantial.

Multiple product manufacturers or services operators also have Overhead Expenses. At Reliable Tailors, depreciation and
rent are examples of Overhead Expenses. If Reliable Tailors were to take a loan for their business, then any interest
payment will be included under Overhead Expenses.
So, for multiple product manufacturers or services operators, there are four different types of costs that make up the total
cost of a product or service. For example, the following are some of the costs to make a dust coat at Reliable Tailors:

Direct Indirect
Direct Material Overhead =
+ Labour + Manufacturing + TOTAL COST
Costs Expenses
Costs Expenses
Multiple product manufacturers or services operators use a Product Costing Form to calculate the cost to produce each of
their products. The Product Costing Form follows the five steps:

STEP1 STEP2 STEP3 STEP4 STEP5

CALCULATE CALCULATE CALCULATE CALCULATE ADD UP TOTAL

Direct Indirect Overhead TOTAL COSTS

Direct
Material Manufacturing Expense per item
Labor Cost per
Cost per Expense per
item
item item

PRODUCT COSTING FORM

(for single product manufacturers and service operators)

Product:

1. TOTAL COST PER MONTH

Total Material Cost per month (1)

Total Labour Cost per month (2)

Total Overhead Expense per month (3)

Total cost per month (4) = (1) + (2) + (3)

2. NUMBER OF ITEMS PRODUCED PER MONTH

Number of items produced per month (5)

3. TOTAL COST PER ITEM (6) = (4)/(5)

 PRODUCT COSTING FORM
(for retailers and wholesalers)

• Overhead Charge (%)

MONTHLY OVERHEAD EXPENSE

= x 100% = %
MONTHLY MATERIAL COST
OVERHEAD CHARGE
1 2 3

Material Cost Overhead Expense per item Total cost per

Product
per item (column 1 x Overhead Charge) item
 PRODUCT COSTING FORM
(for retailers and wholesalers)

• Overhead Charge (%)

MONTHLY OVERHEAD EXPENSE (2)

= x 100% = %
MONTHLY MATERIAL COST (1)
OVERHEAD CHARGE (3)
1 2 3

Material Cost Overhead Expense per item (4) Total cost per
Product
per item (column 1 x Overhead Charge) item
 PRODUCT COSTING FORM
(for retailers and wholesalers)

• Overhead Charge (%)

MONTHLY OVERHEAD EXPENSE $2,000 x 100% =

= 20%
MONTHLY MATERIAL COST $10,000
OVERHEAD CHARGE
1 2 3

Material Cost Overhead Expense per item Total cost per

Product
per item (column 1 x Overhead Charge) item
Groceries and dry foods:

Farmer’s baked
beans, 450g $3.00 $3.00 x 20% = $0.60

Pride flour, 1 kg $3.20 $3.20 x 20% = $0.64