The cost analysis it is defined, in economics, as the measure of the cost-production ratio. That is, economists are concerned with determining the cost incurred in contracting inputs, and how well they can be reorganized to increase the productivity of the firm.
In other words, cost analysis refers to the determination of the monetary value of inputs (labor, raw material), referred to as the general cost of production, which helps to decide the optimal level of production.
Therefore, cost analysis is essential in making business decisions, since the cost incurred in the entry and exit of production must be carefully understood before planning the production capacity of the company..
It is often called a cost-benefit analysis or a cost-effectiveness analysis. A cost analysis requires specific skills to carry it out, and is a useful tool for various aspects of business planning..
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Cost analysis is a comparison of costs. The costs used to prepare the financial statements are not the same as those used to control operations.
Costs can be controllable or uncontrollable and are subject to time frames and restrictions. For example, controllable costs are those that the manager can authorize. However, costs that can be controlled in the long term may not be controllable in the short term..
The scope of the cost analysis will depend on its purpose. Therefore, before considering the scope of the analysis, one needs to know what are the most important questions that the analysis must answer..
You need to know what costs are to be analyzed. This will determine what data will be collected and how it will be classified..
If the company executes very different projects, it is obvious to divide them. However, for projects that overlap or share resources, it must be determined how to separate them..
Projects overlapping to a significant degree can be grouped, rather than evaluated separately, avoiding duplication of effort whenever possible.
The way to classify and calculate costs depends on whether those costs are analyzed in the long or short term.
For example, if you are trying to decide how much to charge for a particular service, you must first determine how much it costs to provide that service.
Subsequently, a longer-term cost analysis would be carried out to see if the company may suffer a loss from the provision of that service..
If the company has performed cost analysis in the past, the same methods or techniques should be used to classify costs.
Maintaining continuity will make the reports comparable, making them more useful over time.
You can also consult cost analyzes prepared by similar companies, projects or similar services..
Direct costs include salaries and benefits for team members, supplies and materials, and necessary accessories.
Direct costs are specific to the project or service that is being evaluated in the cost analysis. They are not shared with any other project.
These costs include the salaries and benefits of management, facilities, equipment, and anything else shared across multiple projects..
Rather than relying on broad financial categories, use categories that accurately express how cost analysis will be used to make it useful to the business..
Categories can include: personnel costs, operational costs, and startup costs. Within each category, identify which costs are direct and which are indirect.
For each cost class to be included in the cost analysis, it must be verified where to obtain the numbers for their calculation.
If you need to estimate a cost, you must specify where the information will be obtained to make a reliable estimate. Actual cost information should be used as much as possible.
Using the information from the collected records, the salaries, materials, supplies and other costs applied only to the project being evaluated are summed.
If a long-term cost analysis is performed, the weekly or monthly direct costs are calculated first, and then spread.
It determines how each cost can be divided among the different projects. The proportion of that cost used by each project is then calculated.
For example, suppose the salary of the human resources manager is being assigned. Since he is responsible for the personnel, it makes sense that his salary is divided between the number of people that make up the work team.
Depreciation of assets used to implement the project, such as furniture, equipment or accessories, should be included in the total project costs.
At a minimum, the cost analysis should provide the business with the true cost of running a project or providing a particular service.
Go back to the purpose of doing cost analysis to determine what actions should be taken.
Cost analysis promotes knowledge of the cost structure involved with the products and services of a company.
When managers are required to collect data to prepare a cost analysis, they will have a deeper understanding of specific elements, such as required work and overhead..
Used for cost evaluation purposes when there is a lack of competition or comparable offers in the market.
There are several cost concepts relevant to business operations and decisions. To understand them, they can be grouped into two categories:
They are used to study the financial position of the company. They serve to organize the finances of the company and to keep track of the assets and liabilities of the company.
They are used for tax purposes and to calculate the profit and loss of the company. These are:
- Opportunity costs.
- Business costs.
- Total cost.
- Explicit costs.
- Implicit costs.
- Out-of-pocket cost.
- Book costs.
They are used to analyze the possible cost of production in the future. They are based on how the cost of production can be managed, or how the input and output of production can be reorganized to improve the profitability of the company. These costs are:
- Fixed costs.
- Variable costs.
- Total cost.
- Average costs.
- Marginal cost.
- Short term costs.
- Long-term costs.
- Sunk cost.
- Historical costs.
- Replacement costs.
Cost analysis provides an opportunity to judge the efficiency of initiatives. For example, a company can analyze the quantity of goods produced from a given level of resources.
Therefore, it helps a company decide if an initiative is delivering value and serves as a guide to improve performance..
The results of a cost analysis report can help a business make better use of available resources. It also serves as documentation showing evidence of liability..
A cost analysis can track expenses, helping a business determine whether or not funds are misallocated.
When there is a lack of price competition in the market, a cost analysis is beneficial. Without price competition, it is difficult to determine if an offer is reasonable.
A cost analysis will help a company evaluate the separate cost elements of a proposal, as well as the proposed benefit, when there are no similar or existing commercial product offerings that can be used for comparison..
For example, when negotiating single source acquisitions, a company will deal with only one supplier. Therefore, it will be impossible to have a bidding process to compare prices.
The manager must clearly understand the cost-production relationship, as this helps in controlling costs, marketing, prices, profits, production, etc. The cost-production relationship can be expressed as:
C = f (E, S, P, T),
where, C = cost, E = Company size, S = Production output, P = Price and T = Technology.
As the size of the company increases, economies of scale also increase, resulting in reduced unit production cost.
Similarly, the price of inputs is directly related to the price of the product. If the price of inputs increases, the cost of production also increases.
However, technology is inversely related to cost. With better technology, the cost of production decreases.
Cost analysis is the process of modeling costs to support strategic planning, decision making, and cost reduction as well. The following are common types of cost analysis.
Development and validation of cost forecasts. It is a fundamental step in planning a business, strategy, program or project.
It is the calculation of the total cost that is expected of owning an asset throughout its useful life.
Costs and benefits are modeled and compared, such as product development costs versus revenue.
Typically estimates such as payback period and return on investment are used.
Cost effectiveness is the process of comparing the costs of strategies in relation to results, where the results are not purely financial.
For example, when comparing different ways to improve quality of life based on cost and non-financial outcomes, such as happiness.
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