Cost price is the price of a product, service, or product by a manufacturer without a trade markup. That is, it is the cost of a production unit that a company spends on producing products without its profit. To determine this indicator, you need to divide all costs by the number of goods produced or services provided.
Why is cost so important?
For a business to run smoothly, you need to know exactly how much it costs to produce a unit of product. This allows you to determine the point at which the business starts making money, rather than spending it.
Determining and controlling cost helps to take into account all possible changes in the market in advance and better plan costs. In the context of strategic planning, cost control helps:
- Effectively optimize costs and increase profitability.
- Monitor production volumes, taking into account demand and the market situation.
- Increase financial revenue and assess overall business efficiency.
Planning and calculating cost allows not only to understand the financial limits within which a company can operate without losses, but also to flexibly respond to changing market conditions, increasing the competitiveness and stability of the enterprise.
Types of cost
For strategic planning and control of individual areas of commerce, cost is divided into several types:
- Shop cost. The total cost of all the costs of the manufacturer's shops. It includes only direct costs that are directly related to the production process. Such costs include the cost of components, raw materials, supplies, and other direct costs. Shop cost complements the total cost and is used for internal analysis and cost control.
- Production. Includes all costs of manufacturing goods. Calculated by adding administrative costs to the shop cost. In addition to materials, direct labor costs, and production costs, this includes indirect costs: logistics, rent, and staffing.
- Total. This is the sum of all costs for the production and sale of goods. It is determined by adding the production cost to the costs of sale. This indicator allows you to estimate the total cost of manufacturing and selling products.
The cost is also divided depending on the moment of calculation:
- Planned. Determined in advance, taking into account a specific time period. When calculating it, average indicators are used, which allows you to make a forecast of planned expenses. This calculation helps in controlling expenses and forming a budget, which contributes to making effective management decisions.
- Actual. Based on actual cost data. It allows you to estimate actual costs and compare them with planned costs to determine work efficiency.
- Normative. Used in organizations that use the normative audit method. Calculated on the basis of specified norms for the costs of material and labor resources. This indicator is used to compare actual costs with planned ones and further analyze deviations.
Calculating various types of cost allows a company to analyze its costs in more detail, make informed and effective decisions, and optimize business processes.
Methods of calculating cost
For this purpose, the following are used:
- Factorial method. Allows you to assess the impact of technical and economic factors on costs for the current year compared to the previous one.
- Estimated method. The essence is to compare planned indicators with actual results, according to estimates.
- Costing method. It allows you to determine the costs of producing a unit of product by comparing similar costing objects.
- Normative method. It evaluates the efficiency of production and sales of products based on standards.
Calculating cost is a complex and detailed process that requires taking into account many factors and can take a significant amount of time.
Examples of cost calculation
After the theoretical part, we will consider practical examples. Let's start with a simple case, gradually complicating it.
Example 1. Single-item production, actual costs
The company "Realt" manufactures chairs of the same type. Work in progress (WIP) inventories are not formed, and finished goods are accounted for at actual cost. The costs of producing 1,000 units of products in March are presented in the table.
Since this is a single-item production, there is no point in allocating indirect costs. All costs are simple - they are simply summed up and divided by 1,000 pieces.
| Indicator | Amount, thousand UAH. |
| Material costs | 500 |
| Salary | 300 |
| Salary deductions | 92,7 |
| Amortization | 15 |
| Other operating expenses | 43 |
| Together | 950 700 |
Cost of one chair:
950,700 ÷ 1,000 = 950.7 UAH.
Example 2. Multi-manufacturing, actual costs
Suppose that the company "Litmus" produces two types of chairs: "A" and "B". In March, 700 and 800 units were produced, respectively. The basis for distributing indirect costs is the basic salary of employees. Here are the initial data for the calculations:
| Indicator | Chair "A" | Chair "B" | Total cost for both types of chairs |
| Direct costs | 692,7 | 1 058,15 | 1 750,85 |
| Additional costs | 78,08 | 136,64 | 214,72 |
| Unit cost, UAH | 1 101,11 | 1 493,49 |
To calculate the cost of one chair, "A" and "B" take into account not only direct costs, but also proportionally distributed indirect costs. The formula looks like this:
1,101.11 = (692.7 + 78.08) ÷ 700 × 1,000
1,493.49 = (1,058.15 + 136.64) ÷ 800 × 1,000
Example 3. Multi-item production, standard costs
For practical purposes, product cost standards are used, in particular, for chairs of types "A" and "B" they are: 1,050 UAH and 1,470 UAH, respectively.
During the month, these chairs are sold at standard prices. At the end of the month, the actual costs are compared with the standard costs. The difference in cost for each type of chair will look like this:
- For chair A: 1,050 – 1,101.11 = -51.11 (cost overrun).
- For chair B: 1,470 – 1,493.49 = -23.49 (cost overrun).
At the end of the period, these variances are attributed to the cost of goods sold increase.
Example 4. Long-run multi-item production
Phoenix manufactures custom furniture. In March, there are three cabinets in production. Two of them were started last month and will be completed by the end of March, and one has a readiness of 80%. Work in progress costs are estimated at actual costs. The base for allocating indirect costs is again the basic salary.
| Indicator | Wardrobe "A" | Wardrobe "B" | Cabinet "C" | Total expenses for March |
| Direct costs | 70 | 90 | 140 | 300 |
| Indirect costs | 56,85 | 26,86 | 115,73 | 199,44 |
| Unit cost | 76,25 | 91,48 | 140 |
The cost of each cabinet is determined by taking into account both direct costs and distributed indirect costs. The peculiarity here is the calculation of costs for cabinet "C", which is not yet completed, so its cost will be estimated according to its readiness.
Calculating the cost of production at enterprises is a complex and variable process. As the examples show, the calculation depends on the cost allocation system (actual or regulatory), the specifics of production (single or multi-item) and the presence of work in progress. The choice of the distribution approach is important for the correct accounting of cost. In real practice, changes in the accounting system are usually made at the beginning of a new calendar year, which allows you to adapt accounting to changes in economic conditions or strategy.
How to reduce the cost of production at the enterprise?
Competitive advantage will always be on the side of manufacturers whose production costs are lower than those of their competitors. Conversely, manufacturers with high costs face difficulties in selling their products and ensuring financial stability, since their minimum markup does not allow them to cover costs.
Increased production volumes
Increasing production capacity is the most obvious and effective way to reduce costs. This is due to the fact that costs can be conditionally divided into variable and fixed. Variable costs directly depend on the volume of production: if the volume increases, costs also increase, and vice versa. Typical variable costs are the consumption of raw materials, wages of workers, energy costs for the operation of equipment.
Fixed costs remain stable despite changes in production volumes. These costs include depreciation of equipment, repairs and maintenance of production facilities.
Increasing labor productivity
Increasing employee efficiency significantly reduces costs. Improving technological processes allows you to get more from the same amount of resources.
Optimization of operating costs
The main effect is achieved by minimizing direct costs for energy resources, employee wages, and maintenance of production equipment. This reduces costs without reducing production volumes.
Reduction in purchase prices for raw materials
Raw materials and supplies usually account for a significant portion of an enterprise's costs (from 50 to 80%). To reduce costs, a company can reduce purchase prices through negotiations with suppliers, the use of discounts and bonus programs, and cooperation with other companies for procurement cooperation.
Reducing technological losses and production defects
Technological losses are non-recoverable waste of raw materials that occur during production or equipment setup. Production defects can be the result of insufficiently qualified personnel or the use of poor-quality materials.
Optimization of production processes
This method requires more in-depth analysis and effort than other approaches, but improving processes can significantly reduce costs and improve other performance indicators at the same time.
Tips for Strategic Cost Reduction
Reducing costs is an important direction for every enterprise, as it allows not only to increase profitability, but also to strengthen competitiveness in the market. To achieve this goal, it is necessary to implement several key strategies:
1. Rational use of material resources:
- When purchasing raw materials, it is important to focus on their quality.
- This avoids additional costs due to defects or unnecessary costs in the production process.
2. Selection of suppliers and transport:
- The cost of raw materials includes not only its price, but also transportation costs.
- The choice of supplier, the distance to it, and the type of transport affect the final cost.
Companies must:
- Carefully select suppliers of raw materials and supplies,
- Work with transport operators that offer favorable delivery conditions.
3. Reduction of transportation and procurement costs:
- Conclusion of agreements with suppliers who provide delivery to the buyer's warehouse.
- Planning intra-workshop movements to prevent pointless transportation.
4. Reducing losses from defects:
The largest non-economic costs are associated with marriage.
Importantly:
- To study the causes of its occurrence,
- Develop strategies to minimize losses.
5. Optimization of the use of production waste:
- Using waste reduces costs.
6. Increase in production volumes:
- Increasing production volumes can reduce its cost.
However, large-scale production of the same type of product may be impractical due to market saturation and changing consumer preferences.
7. Assortment update:
- Updating the product range requires significant costs for replanning workshops and changing technological processes.
This may lead to a temporary increase in cost during the period of adaptation to new products, but in the long term it increases the profitability of production.
8. Production modernization:
- To minimize additional costs, it is important to conduct analytics and plan to reduce costs when updating production equipment.
- The joint work of departments and divisions of the enterprise should ensure maximum effect.
Cost reduction is a multifaceted strategy that includes constant market analysis, technology improvement, automation of production processes, and product range renewal. Only under such conditions can costs be significantly reduced, competitiveness increased, and sustainable development of the enterprise be ensured.
