Business Base

Every company, irrespective of size / geography / market segment, has one factor in common: they exist to make a profit. I have yet to come across a business that, as part of its corporate strategy, has targeted to reduce profitability. But unless we know in detail which products / services / customers are profitable and - perhaps more importantly - which ones aren't, how can we hope to develop a strategy that will increase profitability?

Profit is defined as the difference between the price which a customer pays for a product or service, and the total cost involved in its production and / or delivery. There is seldom much confusion about the first part of this equation; the selling price is usually available directly from the sales invoice or receipt. The difficulty lies in the second part of the equation: calculating the cost.

With so many costing methods to choose from it's no wonder there is such confusion. Each method has its fair share of advocates and opponents, and there are countless books and articles extolling the virtues of one above the others. The biggest concern is that different costing methods can produce startlingly different results. Yet it is the calculation of costs which often drives he most important business decisions: make or buy; bid or no bid; expand the business or close the operation?

What's the right answer?

Without wanting to sound too much like an accountant, the answer depends on the question being asked. The reason so many different costing models have been developed is that they are looking to answer different questions in various different business situations. Companies get into difficulty when they use a particular costing mechanism for a purpose other than that which it was designed for. It's a bit like a doctor using a stethoscope to check a patient's blood pressure - nothing wrong with the instrument, but it's the wrong tool for the job. Target costing, process costing, standard costing, activity-based costing, throughput costing - each has a role to play in particular business situations. The key is to gain an understanding of the main costing "tools" and identify the one which is most suitable for the task in hand.

This is where external professional expertise can be vital. Finding someone who knows the theory and has the practical experience of designing and implementing costing systems can prove invaluable; helping the business select the most appropriate mechanism and develop the costing model to create a sound foundation on which to base decision making and performance measurement. With critical business decisions resting on the accuracy of costing information, this is possibly one of the best investments you will make. Just do the cost-benefit analysis!