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Many small business owners and managers control their operations from a profit and loss or balance sheet perspective. This is fine for end of the year and tax purposes but doesn't help in day-to-day management of simple or complex products, projects, or services. Cost accounting is a technique where repetitive business functions are defined, the costs ascertained, and updated periodically resulting in better bidding/quoting and easier management.
Briefly, regardless of your size or type of business, there are four basic components of a cost accounting model:
1. Direct Costs. These are the labor and material components of everything a company sells. Direct labor is the work product used to build goods and services and/or the in-house work involved in warehousing, distribution, and quality control. Direct materials are the items that go into the product or service (similar to cost of goods sold.)
2. Indirect Costs. These are the labor and service costs performed by others that do not utilize the plant and labor pool of the manufacturer or service provider. For example, if a business produces castings and sends them out for machining, the labor to make the casting is direct and the cost to machine them outside is indirect.
3. Overhead Costs. Overhead is the supporting cost of producing a direct product or service. Items such as rent, heat, telephone, Internet, payroll taxes, and benefits for the direct labor components of the business are a few examples.
4. General and Administrative (G&A) Costs. These costs are generally the costs of the business over and above that which is needed to produce goods or services. Corporate and sales salaries and related costs, rent/utilities for G&A personnel, accounting/legal expenses, non-direct insurance, and the like illustrate this category.
These outlays are typically calculated for a year period, then expressed as a percentage of sales. The end result is generally a formula that breaks a dollar of sales into its direct, indirect, overhead, G&A, and profit components. This enables the manager to cost new work in such a way as to ensure that all costs of doing business, including profit, are covered in each dollar of sales quoted or proposed.
The preparation of these cost figures are more complex and time consuming than demonstrated in this quick tip, but can reap significant rewards if pursued diligently.