One of the most important indicators of doing business is cost price. This indicator must be regularly calculated and analyzed. By calculating the cost price, you will get an idea of whether it is worth selling a product or service at the current price. Cost affects the earned profit and is the key to increasing your bottom line.
In this post, we will help you figure out how to work with it.
Definition of cost price
By starting a business, you are going to sell goods or services. Before you start selling something, you need to produce an item or service. In short, the cost is the amount of money you spend to create a product or service you want to sell.
If you are going to open an online store, then first you need to purchase in bulk the goods that you will sell at retail. Next, you will need to deliver the goods to your warehouse, pay for advertising the goods, and then spend money on delivering the goods to the client who will place an order.
If, for example, you are going to open a car rental and follow the example of successful companies that offer exclusive cars for rent, then you need to understand the cost of services. Rolls Royce rental Dubai price should include car maintenance, car mechanic salaries and other costs. Since there are a lot of risks in this business, one cannot overcharge the price of services to be competitive.
Based on these examples, we can conclude that each area of business has its nuances that need to be considered.
Why do you need to know the cost?
- Cost management. If the cost is more than the price of the product or service, then you will suffer significant losses. It is worth making sure that the cost price is lower than the price of a product or service.
- Determination of the price. By calculating the cost, you will understand the minimum price you can set to outbid the price of direct competitors.
- Comparison with the market price. If in the previous paragraph we understand that it will not be possible to reduce the cost in any way and you will have to sell at a higher price than the market, then you can decide in advance whether it is worth getting involved in the business at all, or it is better to refuse and look for something more profitable.
- Profit management. You will have a clear understanding of how much money you spend on expenses and how much profit you can ultimately count on.
Cost types
- Full. This cost takes into account all the costs that you face. This includes costs of goods sold that are needed to produce or purchase a product or provide a specific service, as well as indirect costs. Large businesses can assess the efficiency of work and the amount of investment and effort for each product produced.
- Direct. It takes into account the financial costs of production and purchase of goods or services These are usually variable costs. The indirect ones are covered by the sale of a product or service. This method is most widely used in a market economy.
Cost calculation
Before calculating the cost, you need to understand what direct and indirect expenses are.
- Direct expenses are money spent on the production or purchase of a particular product or service. For example, if you are in the clothing business, then you need to calculate the costs of fabrics, seamstresses’ salaries, and clothing transportation.
- Indirect expenses are not in any way related to the production of goods or the provision of services. This includes employee salaries, taxes, renting premises, buying office equipment, and more. We do not take such costs into account when calculating the cost.
To make it easier, you can ask yourself: “Will I have any expenses if I do not produce the goods at all?”. If you answered no, then these are direct expenses. If the answer is yes, then these are indirect expenses. The best management accounting books offer several other methods to distinguish between whether a cost is direct or is an overhead.
Breakeven point
It is not always easy to calculate the cost of each product. This happens when you have many different metrics. For example, you make various furniture for the kitchen, bedroom or living room.
Then you can use such a concept as a break-even point. It shows how much money you need to get to cover the expenses and have a profit.
Output
By reducing your cost, you increase your profits. When you have a clear understanding of the cost of your goods and services, you can control the company’s profits.