Best business management practices
Patrick Vigeant
Solutions architect at Witify
A cost price is the sum of the expenses incurred by a company to produce and distribute a good or service. By subtracting the turnover generated by this good or service from the cost price, we can evaluate its profitability .
In other words, costing gives you an accurate view of what each product or service you offer actually costs , helping you set your selling prices and maximize your profitability.
Cost of living is a key indicator for any company looking to control its finances and optimize its margins. Knowing how to calculate and adjust your cost of living is essential to identify areas where you can save money, optimize your processes and ultimately, strengthen the profitability of your company.
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To correctly calculate your cost price, it is crucial to distinguish between direct and indirect costs.
Direct costs include everything that goes into producing a good 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 might be physical components, specific machinery, or the time of employees responsible for assembly.
Indirect costs , on the other hand, concern the distribution and marketing of a good or service . These can include transportation costs, packaging costs, energy costs, administration costs, rental of premises or even equipment maintenance. These costs can 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 will be able to establish a solid basis for accurately calculating your cost price. This also allows you to better visualize where expenses are concentrated and identify areas for optimization.
The calculation of unit cost is based on a simple but essential formula:
Unit cost price = Total direct and indirect costs / Number of units produced
Concrete example: Let's say you manufacture chairs. The raw materials (wood, screws, glue) and associated labor cost $50,000 for a production of 1,000 chairs. Your indirect costs (electricity, rent, maintenance) are $10,000. So the cost per chair calculation would be:
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 cases of multi-level assemblies or products with multiple 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.
When it comes to complex assemblies, calculating cost becomes more tricky. In these situations, there are often multiple levels of production or assembly, each with its own associated costs. For example, if you are manufacturing a product with multiple subcomponents that are manufactured separately, it is important to properly allocate the costs to each stage.
Example of a complex assembly: Consider an industrial machine composed 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 and then add them together to obtain the overall cost.
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Once your cost price is well calculated, the next step is to identify optimization levers to improve the profitability of your business. Here are some strategies to reduce your costs and maximize your margins:
By following these paths, you can transform your cost price calculation into a real lever for continuous improvement. The ultimate goal is to use this data to make informed decisions, reduce your production costs and improve your margins while ensuring optimal service or product quality.
Patrick Vigeant
Solutions architect at Witify
Patrick Vigeant is co-founder and solutions architect at Witify. Specializing in technology, he has spent over 10 years designing innovative digital solutions and developing tailor-made management systems. Particularly experienced in solution architecture, he designs and equips SMEs with a customized technological infrastructure focused on efficiency and effectiveness. Teaching the graduate Web Analytics course at HEC, Patrick enjoys sharing the latest digital trends and keeping in touch with the academic world. Finally, he is involved in his business community as President of La Relève d'Affaires lavalloise.
