1. Introduction: What is costing?
Costing is a key indicator for any company seeking to control its finances and optimize its margins. It represents all costs directly associated with the production of a good or service, from raw materials to labor, assembly and logistics costs. In other words, costing gives you a precise view of what each product or service you offer actually costs you, helping you to define your selling prices and maximize your profitability.
While costing is relevant to businesses of all kinds, this metric is particularly relevant to the production and manufacturing industry, which needs to understand the cost of its often complex products and assemblies. It's a particularly critical approach for these companies, where each cost component can have a major impact on overall margins.
Knowing how to calculate and adjust your cost price is therefore essential to identify areas where you can make savings, optimize your processes and, ultimately, boost your company's profitability.
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2. Identify direct and indirect costs
To calculate your assembly costs correctly, it's crucial to distinguish between direct and indirect costs.
Direct costs include all elements immediately linked to the production of a product or service. This includes raw materials, labor used specifically to create the product, and any other resources directly involved. For example, in a manufacturing plant, this may correspond to physical components, specific machinery or the time of employees in charge of assembly.
Indirect costs, on the other hand, are more diffuse and concern the general smooth running of your business, without being directly linked to a specific product. These may include energy costs, administrative expenses, rental of premises or equipment maintenance. These costs may be difficult to attribute precisely to each unit produced, but their impact on your margins should not be underestimated.
By correctly categorizing these two types of costs, you can establish a solid basis for accurately calculating your cost price. This will also help you to better visualize where expenses are concentrated, and identify areas for optimization.
3. How to calculate unit costs
Unit costing is based on a simple but essential formula:
Unit cost = Total direct and indirect costs / Number of units produced
Here's a concrete example: Suppose you're making chairs. Raw materials (wood, screws, glue) and associated labor cost $50,000 to produce 1,000 chairs. Your indirect costs (electricity, rent, maintenance) amount to $10,000. The calculation of the cost price per chair would therefore be as follows:
Cost per chair = $50,000 (direct costs) + 10,000 (indirect costs) / 1,000 = $60 per chair
This simple calculation allows you to set a selling price that not only covers your expenses, but also generates a profit margin. However, the reality can be more complex, especially in the case of multi-level assemblies or products with several components. This is where an ERP can really make a difference, by automating cost tracking and ensuring that all necessary data is taken into account, from the beginning to the end of the production process.
4. Costing for complex assemblies
When it comes to complex assemblies, costing becomes a tricky business. This is because there are often several levels of production or assembly, each with its own associated costs. For example, if you manufacture a product with several separately manufactured sub-components, it's important to allocate costs to each stage.
Example of a complex assembly: Let's take the example of an industrial machine made up of several modules. Each module has its own direct costs (electronic components, wiring, labor) and indirect costs (electricity, machine tool maintenance). To calculate the total cost of the machine, you must first calculate the cost of each module separately, then add them together to obtain the total cost.
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5. Optimize profitability
Once you've calculated your costs, the next step is to identify ways of optimizing your company's profitability. Here are a few strategies for reducing your costs and maximizing your margins:
- Reduce direct costs
Look for suppliers offering better terms, negotiate volume discounts or explore alternatives to the raw materials you use. Optimizing labor productivity or automating certain production processes can also reduce your direct costs. - Optimizing indirect costs
Analyze your operating expenses: energy, logistics, inventory management. For example, better inventory management through ERP can reduce storage costs and minimize losses linked to out-of-date or obsolete inventory. - Process automation and management via ERP
By adopting ERP, you can not only automate your costing, but also quickly identify the highest cost items. This enables you to react in real time to fluctuations in raw material prices or changes in demand, and optimize your margins without delay. - Identify the right price with unit costing
Once you've established your unit cost, it's easier to set a competitive selling price. This must not only cover all costs, but also generate an acceptable profit margin in relation to the market and the competition. This approach enables you to adjust your prices more precisely and ensure that you don't sell your products or services at a loss or below the desired margins.
By following these guidelines, you can turn your costing into a real lever for continuous improvement. The ultimate aim is to use this data to make informed decisions, reduce your production costs and improve your margins, while guaranteeing optimum service or product quality.
