Importance of Managers Cost Understanding - Essay Example

? Importance of ‘Managers Cost Understanding’ Importance of ‘Managers Cost Understanding’ Outline: Introduction of Cost and Related Terms Importance of ‘Managers Cost Understanding’ How manager’s cost understanding is use Important Areas of Concern Conclusion Work Cited Introduction of Cost and Related Terms Cost Cost can be simply defined as an amount that has to be given up or to be paid in order to get something. It is therefore an expenditure that needs to be incurred. In business, cost usually comprises of monetary valuation of effort, time and utilities consumed, risks incurred, material, resources, and opportunity forgone in delivery and production of goods or services. All expenses may be costs, but not all of the costs (such as those which are incurred in getting an income generating asset) are expenses. (Business dictionary, 2011) Cost Analysis Cost analysis is the examination, accumulation and manipulation of cost information for healthy comparisons and projections. (Business dictionary, 2011) Cost Accounting Cost accounting forms budget and actual cost of processes, departments operations, or product and the analysis of profitability, variances, or social use of funds. It is a type of accounting process whose objective is to capture the company’s costs of production by estimating the costs of input at each step of production along with the fixed costs such as depreciation of capital equipment. At first it will measure and record such costs individually, then comparison between input and output or the actual results will be made to aid company management in measuring financial performance. (Investopedia , 2011) Cost Management It is the management of cost related activities results from collection, analysis, evaluation, and reporting of cost information used for estimating, forecasting, budgeting, and monitoring costs.( Business dictionary, 2011) Cost accounting as form of Management accounting As a form of management accounting, it does not need to follow standards such as those GAAP (General Accepted Accounting Principles), this is because as now its primary in use by internal managers, rather than the outside users, and what to calculate is instead decided practically. Sender’s Name Date Importance of ‘Managers Cost Understanding’ Managers are making use of cost accounting for cost management to help form decisions that are profitable for the business. It is important that managers understand cost in order to cut cost and to improve profitability. Managers make use of cost accounting to calculate the unit cost of the product. This is helpful for managers for if the managers do not know the unit cost they will not be able to set the relevant selling price in order to break even or to realize profit. The calculation of profit per unit can also be known through the use of cost accounting. Cost understanding therefore is an essential management tool for effective management functions, this include performing budgetary planning & controls along with decision making. Managers depend on cost accounting to provide information of the actual cost processes, products, operations which is the foundation of the budget. This would help them analyze fluctuations and the how funds are to be use to cause profit. For managers this would help them provide a justification for cost cuts for a company in a manner that it increases profit. As a tool for internal usage versus tool for external users such financial accountants and such accounting does not make use of GAAP (Generally Accepted Accounting Principles). Management understanding of cost creates a financial value for a product, measure the expenditure into nominal amount of currency. The understanding works on the process of taking recorded historic costs and allocating it over a specific period of time over what outputs is produced. The actual output produce might differ from that of the predicted and this would affect the amount of cost that producer has to pass to the consumer. Hence, managers are able to focus on each time period’s results as it varies to the “standard cost” of any product. The point is to calculate what the overhead versus unit costs are for the companies. Cost analysis would help provide understanding of why cost differs to what was actually planned for. It would help manager better understand the sensitivity of the product with respect to cost as a variable. This would help managers save money by taking appropriate decisions to effect correct variations in future. Variance analysis is also essential for cost management decisions as it breaks the cost in to standard and actual costs. This would help understand the variations in actual cost from predicted outcomes and hence through cost analysis future results could be influenced. It can therefore, be concluded that manager’s cost understanding is vital for determining best ways to boost company’s profit by providing relevant data to analyze particular fluctuation in a particular production costs. How manager’s cost understanding is use Classification of Cost Managers cost understanding would help manager get the cost classified in a manner that it can be optimally used. This would result in classification of cost in different heads: Opportunity cost – this is an important and useful phenomenon of an economic analysis and business decision making. Opportunity cost is the amount that one has to bear in order to achieve something better. Explicit and Implicit Cost – Explicit costs would explain outgoing payments to different parties. Implicit cost is the value of opportunities lost (though it is not part of the actual cost but are as important as explicit cost as these are decision making cost). Sunk, marginal and incremental cost – It is important to have the sunk cost distinguished from other cost as it is an irrelevant cost (not used in decision making). This is the cost that would incur anyway inconsiderate of which option is chosen. Marginal costs are also referred to as the total cost that is associated with every unit change in output (this is a decision making cost i.e. it would affect the decision of a manager). Incremental cost is the total additional cost for implanting a managerial decision. This is important real world cost. Relevant and Irrelevant Cost – Relevant Cost are those which are relevant to decision making process for instance the incremental cost, marginal cost, opportunity cost etc. While, irrelevant cost are those which are ignored in the decision making process that is they are not considered, for instance sunk cost. Direct and Indirect costs – Direct cost can be directly attribute to the production life of a product. Direct and Indirect Costs – Direct costs are directly related to any specific product. On the other hand indirect costs are those which cannot be separated in to the individual units of output. Fixed and Variable Costs – Fixed costs are the ones that occur even when output is nil. It does not differ in changes of output. Whereas, variable cost does change with a change in output, increasing when output increases and decreasing when output decreases. Classification According To Period Short Run Period Cost: It is the time period between which both fixed and variable costs remain unchanged. Fixed costs cannot be influenced but variable costs can be either increase or decrease. Long Run Period Cost It is a period long enough to influence all factors of production that is even fixed factors can be influence. All the factors are known as variable factors of production. Cost Output Relationship Formula Total cost = Total Fixed Cost + Total Variable Cost It can even be represented in a chart: Total Fixed Cost Curve The above figure sure The total fixed cost curve that remains fixed with the level of output. Total Variable Cost Curve TVC is known as the total variable cost that changes directly with respective change in output. It refers cost of labor, raw material, power etc. The Cost Output Relationship can even be drawn on chart: The TC, TVC & TFC Curves Importance of Classification Classification of costs is very essential in decision making as the units might be sold at a single price but the cost of producing each variable might not be same. It is important for management to consider relevant and variable cost in decision making and ignore the rest. Important Areas of Concern Setting Prices Setting the prices for goods or services require several factors consideration, the most important being cost of the product itself. The price must be set in a manner that it is sufficient to exceed the product and period cost this would help company earn the desirable profit or to break even at least. Breakeven is the point where the marginal cost equals to marginal selling price; this is a no profit and loss position. It is important for a manager to recognize this point as beyond this he could only realize loss. Budgeting Planning and Control Managers make use of budgets to help with the planning and controlling of a business current and future market position. A budget is a formal document or a written expression of company’s plans for a particular time stated in financial terms. Such control is important for comparing actual operating outputs to planned operating outputs and hence helps managers identify problem areas to produce corrective actions. Investment Appraisal Companies with excess amounts of funds must make decisions regarding investment of these funds in order to use their potential to the best extent. There are choices in long-term projects that require use of techniques of capital budgeting, to choose from many capital projects the best. These will be those that earn the maximum return on the amount invested. For making healthy comparison among projects it is important that managers identify relevant cost and sum the cost as the total amount that has to be invested. Then, using any of the appraisal techniques the comparison is made. Whichever project earns greater return on invested capital would be chosen. Standard Cost and Variance Analysis Standard costing is the predetermined costs; an important of this is variance analysis that helps breaking down the cost into standard and actual costs in order to improve future profit margins. Variance analysis, in budgeting (or in general management accounting), is a budgetary control tool by evaluation of performance using variances between budgeted amount, standard amount or planned amount and the actual amount. Conclusion Manager’s understanding of cost is essential for reducing cost and improving profits. A company can only run if its liquidity position (cash position) and profit position is high. This would only occur when cost are low. Therefore, from Management's expression, "What a product should have cost" is more important than."What it really did cost". Managers have to compare their product cost with "What it should have cost". Reasons for deviations are the ones rigorously analyzed and responsibilities are quickly fixed. Thus, "what a product should have cost" is a question that is of great concern to management for improvement of cost performance and firms’ profitability. Work Cited Websites 1. Business Dictionary(2011), ‘Cost ‘ from http://www.businessdictionary.com/definition/cost.html 2. Business Dictionary(2011), ‘Cost Analysis‘ from http://www.businessdictionary.com/definition/cost-analysis.html 3. Investopedia(2011), ‘cost accounting’ from http://www.investopedia.com/terms/c/cost-accounting.asp 4. Business Dictionary(2011), ‘Cost Management’ from http://www.businessdictionary.com/definition/cost-management.html 5. Loscostos. The Costs ‘General Classification of cost’ from http://www.loscostos.info/english/classification.html 6. Why is cost accounting essential for management from http://wiki.answers.com/Q/Why_is_cost_accounting_essential_for_management#ixzz1LqvDWXjs Books 7. Eldenburg, Leslie G., and Susan K. Wolcott. Cost Management: Measuring, Monitoring, and Motivating Performance. John Wiley & Sons, 2004. 8. Hitt, Michael, Stewart Black, and Lyman Porter. Management. Prentice Hall. 2005. 9. Horngren, Charles T., Gary L. Sundem, and William O. Stratton. Introduction to Management Accounting. Prentice Hall, 2005. 10. Rasmussen, Nils H., and Christopher J. Eichom. Budgeting: Technology, Trends, Software Selections, and Implementation. John Wiley & Sons, 2004. 11. Robbins, Stephen P., and David A. DeCenzo. Fundamentals of Management. Prentice Hall, 2005. 12. Weygandt, Jerry J., Donald E. Kieso, and Paul D. Kimmel. Managerial Accounting: Tools for Business Decision Making. John Wiley & Sons, 2005. 13. Whitten, David A., and Kim Cameron. Developing Management Skills. Prentice Hall, 2005. Read More