Plain and Simple: Bright Business Insights Fall 2018 | Page 2

YOU CAN’T MANAGE WHAT YOU CAN’T MEASURE Understanding Your Costs is Key to Making Sound Business Decisions When it comes to managing a business, the most common measuring Direct Labor – Best defined as all personnel costs required to Distribution – Lastly, distribution costs can be defined as all are using, and what you pay your supplier for those raw materials. stick owners use to determine their success is profit. To measure profit, directly manufacture a finished product, direct labor is the next costs required to move your product, in its finished state, to your Direct labor is also relatively straightforward. Figure out how much however, you not only need to understand the revenue that was brought main component of cost. Sticking with the example of producing customers. This includes costs such as freight paid to a common it costs to employ your production workers on a per-hour or per-day in, but also the costs that were incurred along the way. Those who a chair, this would be the compensation for the person assembling carrier and compensation paid to the dedicated employees who basis, and how many units can be made in that same amount of time, truly understand their costs and how they impact profit will ultimately the legs, seat and backrest to make the chair complete and ready ship your products. Many times, these costs are lumped in with and you should be good to go. Even distribution costs are usually manage their business more effectively and, well, be more profitable. to sell. Remember that compensation doesn’t just mean wages. It overhead. Doing this is OK, but may hinder your ability to known with a pretty high level of accuracy. It’s hard to argue what the includes other costs such as benefits, training and paid time off. effectively understand and manage these costs. This could play cost is to ship something when the carrier you have chosen to ship it for It’s essential to consider these other elements of compensation for an even bigger role if distribution costs are a large percentage of you has told you what the cost is. To understand your costs, it’s imperative to understand the different production employees when trying to determine your total direct your total cost, or if your practice is to pass these costs on to your types of costs. For example, when it comes to manufacturing, costs are labor cost. customers. The Four Types of Costs generally categorized into one of four buckets: direct materials, direct labor, overhead and distribution. Overhead – Now that direct materials and direct labor are accounted for, you should look at your overhead next. Overhead Direct Materials – Also called raw materials, these materials is all other costs needed to run your facility and produce your become an integral part of the finished product as it is sold to products. Some of the most common examples are depreciation, customers. A good example might be the wood that is used to rent, supplies, insurance, management and administrative produce a chair. This cost is usually fairly easy to calculate compensation. While it usually isn’t too tough to pick out what for a given product and, in general, most people have a good makes up overhead, understanding the behavior and tendencies understanding of what these costs are. that these costs exhibit can be difficult. So, What Does It Cost To Produce That Chair? Trying to figure out what the true cost is to produce a certain product can be tricky and, if done incorrectly, can lead to poor business decisions. However, if you learn to understand the cost that goes into production, you will effectively arm yourself with information designed to help you set prices, engage customers and make production decisions. So, how can this process be tricky if three out of the four components can be pretty well understood? The answer is the fourth component: overhead. Is Overhead Over Your Head? It almost goes without exception that all organizations struggle with how to accurately assign overhead costs to their products. One of the main reasons is that overhead tends to be fixed and, therefore, doesn’t go up or down with production volume. Because of this, the amount of The specific direct material cost of a product is usually quickly overhead that can be assigned to specific units of product will heavily ascertainable. You can figure out how much of each raw material you depend on your production volume. The key is understanding your current and future production. Additionally, when assigning overhead costs, it’s important to understand what’s driving these costs. With the rapid advancement of technology, a lot of processes, and the amount of output they can generate are controlled by machines instead of production workers. Historically, one of the most common cost drivers used to assign overhead was labor hours. If that is the case and machines are now in control of a process, then labor hours may not be the most appropriate way to assign your overhead costs. In short, a thorough understanding of your manufacturing process is absolutely necessary to help you determine your most appropriate cost driver. An in-depth understanding of your costs will greatly empower you as you make crucial decisions regarding your business. If taking a look at this is something that you feel would be beneficial for you and your business, give me a call to learn more. by: Andrew Geiser, CPA Supervisor 212 North Washington St. Millersburg, OH 44654 330.521.4562 [email protected]