A variable cost changes when the volume of production changes.
Cost is the economic expense represented by the manufacturing of a product or the provision of a service. By determining the cost of production, the public sale price of the good in question can be established (the public price is the sum of the cost plus the profit).
The cost - also called cost - of a product is made up of the price of the raw material , the price of the direct labor used in its production, the price of the indirect labor used for the operation of the company and the amortization cost of machinery and buildings.
Costs of a company
Specialists affirm that many businessmen usually establish their sales prices based on the prices of their competitors, without first determining whether they are able to cover their own costs. For this reason, a large number of businesses do not prosper since they do not obtain the profitability necessary for their operation. This reflects that cost calculation is essential for proper business management.
The analysis of business costs allows us to know what is spent, where, when, how much, how and why, which enables better management of the future.
In other words, cost is the economic effort that must be made to achieve an operational objective (paying salaries, purchasing materials, manufacturing a product, obtaining funds for financing, managing the company, etc.). When the desired objective is not achieved, a company is said to have a loss .
When the level of sales equals the costs, the break-even point is reached.
Comparison with the competition
One of the greatest incentives to calculate production costs appropriately is the growing number of competitors that appear as a natural consequence of globalization . The equation is much more difficult to solve than a purely mathematical vision can offer us: it is not enough to obtain an attractive sales price, but each variable must be thoroughly analyzed to guarantee the company a promising future.
As mentioned in a previous paragraph, one of the most common mistakes made by companies is to simply improve the prices offered by their competitors. This is an impulsive and not very responsible strategy that can lead to bankruptcy. However, it is also not correct to affirm that the solution always consists of reducing production costs until the winning price is achieved, because in this way we would be leaving aside the consumer's expectations: are they really "asking" for a lower price or do they favor other issues?
In some cases, the best decision companies can make is to focus on adjusting their messages so that people can appreciate the benefits of their products and are convinced to choose them over the competition, even if their prices are higher. Needless to say, this strategy is very risky and can also lead to bankruptcy, but if it works, the benefits are multiple.
The cost of labor is the money that goes to compensate workers.
Difficulties in calculating costs
On the other hand, we must not forget one of the complications that comes with the international distribution of products: prices must be calculated taking into account taxes and the stability of the currency of each region, among other determining factors. This sparks complaints from consumers when they learn that in other countries the same item is much more affordable in proportion to the minimum wage and average monthly expenses.
Calculating labor costs is difficult, since factors such as employee fatigue or effort cannot be objectively accounted for; For this there are global parameters that all companies can observe. With respect to materials, you should look for the best offers and seek beneficial contracts to never opt for inferior quality at a better price.
It cannot be ignored that the cost is not an expense, but an investment : if the business is profitable, the value of the budget that is allocated to the costs is then exceeded by the income obtained thanks to the sale of the product or the service fee. The difference between revenues and costs reveals the profit margin .
When carrying out cost analysis, therefore, one should not only focus on savings but rather consider efficiency . There is no point in cutting a fixed cost if it leads to a drop in quality and then fewer sales, to mention one possibility. Factors external to the company must also be taken into account, such as inflation, currency depreciation, etc., which may mean that cost reduction is not possible or, at least, not profitable .
Cost control, in short, has to be framed in a broader financial analysis . Budget management must consider numerous variables, with resource optimization being one of the axes that guide actions and decisions.