The calculation of estimated costs is important in project management and in the strategic planning of a company.
Estimated costs are a tentative calculation that predicts how much it could cost to produce a good or offer a service . It is an estimate that aims to anticipate real costs and is a very important element of a budget .
The difference between estimated costs and actual costs is called variation or deviation . As the exercises occur, it is possible to make the necessary adjustments to reduce or eliminate this variation.
How estimated costs are calculated
Estimated costs are calculated by analyzing different variables. The value of labor necessary for production, as well as the value of raw materials, must always be considered. On the other hand, indirect expenses , such as transportation or electricity, must be added.
It is important to note that estimated costs do not usually remain static. The price of raw materials can vary, as well as the wages of workers. In some cases, it should be considered that costs may increase due to the maintenance required by machines, devices, etc.
Estimating costs is carried out in various ways. The most common is to review the costs that were recorded in past periods to anticipate what they will be like in the future. This methodology, of course, faces caveats such as the problem of inflation or the appearance of technological innovations that modify the production process.
Another alternative is the so-called bottom-up estimation . In this case, the cost of each component is calculated separately and finally added to arrive at the total estimate.
An additional possibility is to resort to specialist consulting . Experts in the market in question can draw on their knowledge and experience to predict what the costs will be.
Resource planning should be based on estimated costs.
Its usefulness
The usefulness of estimated costs lies in the chance to make a prediction of the expenses associated with a productive or commercial activity. In this way, estimated costs contribute to financial planning since they provide key information to define the allocation of resources .
When carrying out a cost analysis, it must be considered that there are different typologies or classifications. It is possible to differentiate, on the one hand, between fixed costs (they do not change due to small modifications in business activity) and variable costs (they change according to the level of activity or the volume of production). Another look should focus on the direct cost (unequivocally linked to the production process) and the indirect cost (affects more than one product). An additional alternative is to distinguish between the cost of production and the cost of sales .
Estimated costs generally refer to total costs . They offer valuable information because they provide a guide to examine, taking into account those expenses, how much income is needed to obtain profitability . That is why they help in setting sales prices and developing quotes.
The estimated costs that are anticipated from a scenario analysis contribute to financial forecasting.
Main characteristics of estimated costs
Estimated costs must be based on accurate information . They can be calculated taking into account previous years or undertakings with similar characteristics: the important thing is that the figures arise from concrete data.
Likewise, the estimated costs must be anticipated considering all the costs related to the project. No factor should be left out that, in one way or another, may influence the determination.
Given that the data must be specific and the view must be comprehensive, it is understood that the estimated costs are realistic . This is an essential quality for them to be useful. If this path is abandoned and one proceeds to make unfounded assumptions or try to guess, the company runs risks because reality may be very different compared to what was anticipated.
Possible problems in the calculation
Problems may arise related to the calculation of expected costs. In a broad sense, the lack of capacity of those who make the estimate can lead to multiple errors.
Among the errors that can be incurred, one of the most frequent is the lack of precision . If the deviation of estimated costs from actual costs is very large, the financial projections will surely have been wrong.
Many times the difficulty is linked to an erroneous calculation of indirect costs . They may even not be applied due to forgetfulness or ignorance.
Reference may also be made to certain limitations on the estimated costs. In this framework we must talk about opportunity cost , which refers to those benefits that are not achieved by choosing one alternative and discarding another. Considering estimated costs does not provide useful information about opportunity cost.
Minimizing the drawbacks with cost accounting ultimately facilitates profitability analysis and helps find the equilibrium point from which profitability is achieved.