COST ANALYSIS: HOW IT IS DONE, WHAT IT IS FOR AND EXAMPLES - DUDAS - 2025

The cost analysis is defined in economics as the measure of the cost-output ratio. That is, economists are concerned with determining the cost incurred in contracting inputs, and how well they can be reorganized to increase the productivity of the firm.

In other words, cost analysis refers to the determination of the monetary value of inputs (labor, raw material), referred to as the general cost of production, which helps to decide the optimal level of production.

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Therefore, cost analysis is essential in making business decisions, since the cost incurred in the entry and exit of production must be carefully understood before planning the production capacity of the company.

It is often called a cost-benefit analysis or a cost-effectiveness analysis. A cost analysis requires specific skills to carry it out, and is a useful tool for various aspects of business planning.

Comparison of different costs

Cost analysis is a comparison of costs. The costs used to prepare the financial statements are not the same as those used to control operations.

Costs can be controllable or uncontrollable and are subject to time periods and restrictions. For example, controllable costs are those that the manager can authorize. However, costs that can be controlled in the long term may not be controllable in the short term.

How is a cost analysis done?

-Define purpose and scope

What is it needed for

The scope of the cost analysis will depend on its purpose. Therefore, before considering the scope of the analysis, one needs to know what are the most important questions that the analysis must answer.

Identify the perspective

You need to know what costs are to be analyzed. This will determine what data will be collected and how it will be classified.

Differentiate projects

If the company executes very different projects, it is obvious to divide them. However, for projects that overlap or share resources, you must determine how to separate them.

Projects overlapping to a significant degree can be grouped together, rather than evaluated separately, avoiding duplication of effort whenever possible.

Set the time period

How you classify and calculate costs depends on whether those costs are analyzed in the long term or in the short term.

For example, if you are trying to decide how much to charge for a particular service, you must first determine how much it costs to provide that service.

Subsequently, a longer-term cost analysis would be carried out to see if the company could suffer a loss from the provision of that service.

-Categorize costs

Review previous reports

If the company has performed cost analysis in the past, the same methods or techniques should be used to classify costs.

Maintaining continuity will make the reports comparable, making them more useful over time.

It is also possible to consult cost analyzes prepared by similar companies, of similar projects or services.

List direct costs

Direct costs include salaries and benefits for team members, supplies and materials, and necessary accessories.

Direct costs are specific to the project or service that is being evaluated in the cost analysis. They are not shared with any other project.

Include indirect costs

These costs include the salaries and benefits of management, facilities, equipment, and anything else shared across multiple projects.

Organize costs

Rather than relying on broad financial categories, use categories that accurately express how cost analysis will be used to make it useful to the business.

Categories can include: personnel costs, operational costs, and startup costs. Within each category, identify which costs are direct and which are indirect.

-Calculate costs

Collect financial information and records

For each cost class to be included in the cost analysis, check where to obtain the numbers for their calculation.

If you need to estimate a cost, you must specify where the information will be obtained to make a reliable estimate. Actual cost information should be used as much as possible.

Direct project costs

Using the information from the collected records, the salaries, materials, supplies and other costs applied only to the project being evaluated are added.

If a long-term cost analysis is performed, the weekly or monthly direct costs are calculated first, and then spread out.

Allocate indirect costs

It determines how each cost can be divided among the different projects. The proportion of that cost used by each project is then calculated.

For example, suppose the salary of the human resources manager is being assigned. Since he is responsible for the personnel, it makes sense that his salary is divided between the number of people that make up the work team.

Calculate asset depreciation

Depreciation of assets used to implement the project, such as furniture, equipment or accessories, should be included in the total project costs.

-Conclusions

At a minimum, the cost analysis should provide the business with the true cost of running a project or providing a particular service.

Go back to the purpose of doing cost analysis to determine what actions need to be taken.

What is it for?

Cost analysis promotes knowledge of the cost structure involved with a company's products and services.

When managers are required to collect data to prepare a cost analysis, they will have a deeper understanding of specific elements, such as required work and overhead.

It is used for cost evaluation purposes when there is a lack of competition or comparable offers in the market.

There are several cost concepts relevant to business operations and decisions. To understand them, they can be grouped into two categories:

Cost concepts for accounting purposes

They are used to study the financial position of the company. They serve to organize the finances of the company and to keep track of the assets and liabilities of the company.

They are used for tax purposes and to calculate the profit and loss of the company. These are:

- Opportunity costs.

- Business costs.

- Total cost.

- Explicit costs.

- Implicit costs.

- Disbursement cost.

- Book costs.

Cost concepts for economic analysis

They are used to analyze the possible cost of production in the future. They are based on how the cost of production can be managed, or how the input and output of production can be reorganized to improve the profitability of the company. These costs are:

- Fixed costs.

- Variable costs.

- Total cost.

- Average costs.

- Marginal cost.

- Short-term costs.

- Long-term costs.

- Sunk cost.

- Historical costs.

- Replacement costs.

Importance

Cost analysis provides an opportunity to judge the efficiency of initiatives. For example, a company can analyze the quantity of goods produced from a given level of resources.

Therefore, it helps a company decide if an initiative is delivering value and serves as a guide to improve performance.

The results of a cost analysis report can help a business make better use of available resources. It also serves as documentation showing evidence of responsibility.

A cost analysis can track expenses, helping a business determine whether or not funds are misallocated.

Applications

When there is a lack of price competition in the market, a cost analysis is beneficial. Without price competition, it is difficult to determine whether an offer is reasonable.

A cost analysis will help a company evaluate the separate cost elements of a proposal, as well as the proposed benefit, when there are no similar or existing commercial product offerings that can be used for comparison.

For example, when negotiating single-source acquisitions, a company will deal with only one supplier. Therefore, it will be impossible to have a bidding process to compare prices.

Cost-production ratio

The manager must clearly understand the cost-production relationship, as this helps in controlling costs, marketing, prices, profits, production, etc. The cost-production relationship can be expressed as:

C = f (E, S, P, T), where, C = cost, E = Size of the company, S = Output of production, P = Price and T = Technology.

As the size of the company increases, economies of scale also increase, resulting in a reduction in unit production cost.

Similarly, the price of inputs is directly related to the price of the product. If the price of inputs increases, the cost of production also increases.

However, technology is inversely related to cost. With better technology, the cost of production goes down.

Examples

Cost analysis is the process of modeling costs to support strategic planning, decision making, and cost reduction as well. The following are common types of cost analysis.

Dear

Development and validation of cost forecasts. It is a fundamental step in planning a business, strategy, program or project.

Life cycle cost analysis

It is the calculation of the total cost expected of owning an asset over its useful life.

Cost benefit analysis

Costs and benefits, such as product development costs versus revenue, are modeled and compared.

Typically estimates such as payback period and return on investment are used.

Cost effectiveness

Cost effectiveness is the process of comparing the costs of strategies in relation to results, where the results are not purely financial.

For example, when comparing different ways to improve quality of life based on cost and non-financial outcomes, such as happiness.

References

1. Business Jargons (2019). Cost Analysis. Taken from: businessjargons.com.
2. Wikihow (2019). How to Do a Cost Analysis. Taken from: wikihow.com.
3. John Spacey (2017). 5 Types of Cost Analysis. Taken from: simplicable.com.
4. Kelley Katsanos (2019). Introduction to a Cost Analysis Report. Small Business - Chron. Taken from: smallbusiness.chron.com.
5. The Library of Economics and Liberty (2019). Cost-Benefit Analysis. Taken from: econlib.org.
6. Universal Class (2019). How to Perform a Cost Analysis. Taken from: universalclass.com.