Estimating Costs

For any company, planning is important, and budgeting is one of the important aspects of planning. Estimating a cost of product properly is essential for any company. Cost of any product increases if the demand of the product is more.

Cost of any product includes:
  •  Production cost
  •  Distribution and selling cost
  •  Risk cost.
i.Types of Cost:

Cost is how much a company spends on a product to make it available to the end-user. There are two types of costs: fixed cost and variable cost.

i) Fixed Cost: Fixed cost does not change with production or profits, which means a cost which is fixed for any company to occur. It includes payment of bills for rent, electricity, salaries of the employees; interest etc. all this is must for a company to pay regardless of the output.

ii) Variable Cost: Variable cost varies with the number of unit produced by a company. For one unit the cost is fixed but the cost for a company varies as the number of unit varies. For e.g. for a milk pouch the cost of milk and packaging cost is fixed however depending on the number of milk pouches the cost changes.The other costs are Total cost and Average cost. Total cost is the sum of fixed and variable cost for any specified level of production.

Total cost = Fixed cost + Variable cost

Average cost is the cost per unit at the specified level of production. Average cost is equal to the total cost divided by the production cost.

Average cost = Total cost / Production

ii. Correlation Between Costs and Production Cycle 

Cost of any product is correlated with its scale of production. As the scale of
production increases, the fixed costs are allocated over more units of the product and also the production learning is embedded into the process thereby reducing variable cost per unit of the product. For example, Amul and Nestle launched packed curd in the market. In the initial stages itself Amul captured higher market share i.e., started selling more units of packed curd. This led to reduced cost of packaging per unit of curd and also reduced transportation cost per unit. While for Nestle the profitability of packed curd was reducing as the cost of production was high and the sales was declining. This led to Amul further increasing its market share.

iii. Target Costing

Target costing is a method by which a company determines the ways to achieve the success by planning the services provide, designing the products, processes and related cost structures that provide value to the customer. Cost of a product changes with the production, which can further be reduced by careful planning of the managers, engineers, and agents. The steps involved in Target costing method are shown in below fig.

The objective behind performing these steps is to find out whether the final cost comes in the target costing range. If it does not in that case a company may take the decision of not entering into that product market as the company will not earn profit in that case.

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