Inaccurate information about your company’s expenditure can greatly inhibit your capacity to make and maintain a successful business. Accurate costing information enables managers to measure profit, so that they can make the best decisions for the company’s future. Below, we summarize precisely why accurate costing is so crucial to the success of any business.
Accurate costing helps businesses stay competitive
To be as competitive as possible, you need to understand exactly how much your company spends on any given asset. This way, you have a reliable means of setting competitive sales prices that will encourage profit and attract consumers. Inaccurate costing information may lead to mistakenly setting lower sales prices relative to your expenditure, which ultimately decreases profit.
Inaccurate costing information may even put you at risk for charges of predatory pricing practices. If you have inaccurate information about your expenditure, you may mistakenly set sales prices at a lower amount than costs. In some places, this merits legal action, and a business can be sued for using artificially low prices in attempts to drive competitors out of business. Accurate information about costing will help to protect you against costly mistakes like this.
Making smart choices
Some of the most important business decisions you will make will be heavily influenced by cost factors. In these situations, you will often have to choose one alternative over another, and this involves distinguishing between relevant and irrelevant costs.
The original cost to your company of any given asset, before accounting for depreciation, can easily be mistaken as a relevant cost. However, it is in fact the disposable value of this asset which is the relevant amount, rather than the original cost.
Imagine, for example, that your company bought certain machinery for its operations at a cost of $35,000. When deciding between keeping this machine or replacing it with a new one, the relevant cost is its value after accounting for depreciation.
So, let’s say that the machine at this time has a salvage value of $20,000. This is the relevant cost that you should consider when deciding whether to sell the asset or keep using it. Being aware of the difference between irrelevant and relevant costs will help you to consider the future cash flows of each action, rather than simply considering the historical-based costs to your company.
Relatedly, you need accurate costing information to help you to value assets. The balance sheet will record the cost values for most assets, and in order to understand these you need to also understand the cost basis of its inventory and certain other assets.
Lastly, having accurate costing information will help you to measure gross margin. Subtracting your cost of goods sold expense from your sales revenue influences your bottom-line profit figure. This figure is what managers and investors use to judge business performance, so getting it right is imperative. This figure is also the first profit line in the income statement, so if your gross margin is wrong, bottom-line net income will also be wrong. Avoiding this situation and identifying an accurate gross margin depends heavily on having correct product costs.
Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. Melanie has been writing about inventory management for the past three years. When not writing about inventory management, you can find her eating her way through Auckland.