To outline the product cost and budgetary control methodologies that could be used by an organization to expand its market outreach.
Budgetary control and financial management at Worplestrop Partnership involves the organizing, controlling, directing, planning and monitoring of monetary resources in our organization.
Cost in business represents the value of raw materials in monetary terms that are used to produce a good or a service. All costs incurred before the product acquires a saleable state are captured in the total cost. In a business environment, every input is obtained at a cost. This means that to every product a value is attached. Every organization endeavors to produce high quality goods at the lowest cost. To do so organization must embrace lean production. That is, products are launched with a crystal clear understanding of the markets needs. (Horne 2009)
Product costing is a way of ensuring that all costs related to production of a good or service are incorporated in the production cost. It is a lengthy process that starts at the acquisition of raw materials, tracking labor expenses to adding the transportation costs as the saleable product is transported to retail firms. (Kirkham 2003)
For instance, at Worplestrop, garment manufacturing will acquire raw materials say rolls of cotton materials. A processing exercise begins, with the rolls passing through machines which either driven by electricity or oil, and probably needs cooling at intervals. As a matter of fact, operators are needed to ensure quality production. All these are carried out in space where rent is paid at certain intervals of time as agreed by the tenant and landlord. (Brimsom 1999)
In accounting, a place in an organization whereby value addition takes place to products is referred to as a cost centre. Cost centre may be a department. On the other hand, the product upon which the cost is incurred is called a cost unit. (Brimsom1999)
This is also referred to as the direct costing technique and is an accounting technique whereby the fixed costs relating to production of a product are deemed irrelevant. Marginal cost of a product refers to the variable cost components only. Conventionally, variable costs are direct labor, direct raw materials, and direct expenses as well as the variable part of the overheads (Berliner 1988).
The underlying reason behind the exclusion of fixed costs from the analysis is that the fixed costs bring only slight changes to the model, since no alteration can be done on the fixed component in the short term. The resultant formula then is changing the variable costs to the cost units while the fixed costs for the period under revealed are written off. This is done against total contribution.
By the formulation;
MARGINAL COST = VARIABLE COST = DIRECT EXPENSE + VARIABLE OVERHEADS + DIRECT MATERIAL.
CONTRIBUTION= SALES – MARGINAL COST. (Berliner 1988)
Contribution is the profit obtained from the production before the recovery of fixed costs incurred in the production process. In this costing methodology, a business is advised to produce all products with a positive contribution, with more emphasis on the ones with the highest value of contribution. When valuing any unsold goods (closing stock), the products carry only the variable component of the cost. (Berliner 1988)
Assumptions of the model
Increased level of activity (production) in a certain period reduces the cost per unit, in normal circumstances. Taking an example of the employees in the production department to be twenty (20), if the monthly wage for them is $600000 and on average they produce a total of 1000000 units, the direct labor cost per unit is;
$600000/1000000 = $0.6 per unit. (Berliner 1988)
If production efficiency is enhanced in the production department and as a result, the same numbers of employees now produce 1,200,000 units at the existing wage rate, then the direct labor cost per unit becomes:
$600,000/1,200,000 = $0.5 per unit. (Berliner 1988)
When the increment in output is greater than a unit (1) then the total increase in cost divided by the total increase in output will give the marginal cost per unit.
For instance, if output has increased from 1000000 to 1200000 whereas the total cost to produce these units is $600000 from $500000 then the average marginal cost per unit is given by the calculation below:
Average marginal cost = additional cost/additional units; i.e.
$100,000/200,000 = $0.5. (Brimsom 1999)
Essentials of marginal costing.
It is a simple method of analyzing production, since only direct costs are considered and the complex procedures of apportioning fixed overheads in to closing stock is totally avoided. Quick decisions can be made from the analysis. (Kirkham 2003)
Short-term profit planning by break even and profitability analysis is enhanced.
This procedure of valuing products is also called indirect or full costing technique. It aggregates the full cost of production or provision of service. As a result, all the overheads, regardless of whether fixed or variable are before arriving at the contribution per unit. (Horne 2009)
In this method, unsold units at the end of the period have both components of fixed and variable costs. For the period under review, fixed cost are included when calculating contribution.
Contribution = sales – total costs (variable + fixed); this shows that
Contribution = net profit/net loss. (Berliner 1988)
Costing technique. (Horne 2009)
Decision making in marginal costing is very fast since few things are put in to consideration. The mere exclusion of overheads and fixed costs significantly reduces the calculations involved before arriving conclusion. On the other hand, in absorption costing overheads, especially the fixed overheads have to be allocated to cost centers
Excerpt from a report
The analysis given below is an excerpt from the human source resource on the level of employee participation. Good working environment would increase morale among workers and enhance good communication.
Level of Engagement
Employees who claimed to be Highly Engaged
Loves his/her job; personally and professionally secure; committed to excellence
81 – 100
Employees said they were just Engaged
Often knows expectations; secure; easily motivated
60 – 80
Employees who admitted to be Disengaged
Questions his/her expectations; insecure; dissatisfied
41 – 59
Does not know expectations; terrified; fearful; very bitter
0 – 40
In the light of the above analysis, absorption costing will produce far better results when accuracy of the information is considered. Again the fact that all the closing and opening stocks are valued in a much better meaningful way makes the model effective than marginal costing. To cap it all, results generated has been refined, having taken care of every cost element even fixed overheads. I would recommend this method if the team has qualified analysts who can take care of all this calculations accurately. Again for information that is not required urgently, this is the best way to follow since the end product is always refined. (Horne 2009())
In case the information is needed urgently, marginal costing becomes the best method to follow since it eliminates the calculations of overheads. But the management team should tread this way with a lot of caution since the analysis leaves some important information uncovered. Hence, using supplementary sources of information in addition to the marginal reports is highly recommended. (Horne 2009)
Other cost and Budgetary control measures
The fact that a business operates under different departments creates a bunch of uncertainties on cost reduction methods that allow the firm reduce avoidable expenses. Taking an example, a typical business firm has a purchasing department which is tasked making acquisitions of all the material requirements of the business. Production department manufactures raw materials to saleable goods, prior to marketing (Kirkham 2003).
Projections on what to acquire apparently precedes any production activity, with the process hinged on several factors among them the external demand, which is deemed the overall determinant, analysis of the competition by the rival firms vis-a-viz the company’s market share. All this factors not only affect the profitability of the business but also the sustainability of the model in the future, which underlines the need for prior planning (Berliner 1988).
Apparently all businesses engaging in manufacturing activities have unsold items as well as unfinished products from the manufacturing department at the end of the trading periods, commonly known as the closing stock and work in progress respectively. This makes the issue of storage space a very important aspect in maintaining quality of products. Availability of finished products in the store necessitates regulation of current production in order to avoid unnecessary losses as well as tying up capital in slow moving products. Below is a sample methodology brought forward as a way of increasing the effectiveness of budgeting. This method seeks to our operation volumes at low cost and minimal risk. (Horne 2003)
Adoption of just in time technique. (JIT)
This is a mode of production whereby the business seeks to minimize the storage costs of both raw materials and finished products in their stores. It is imperative that most businesses resort to using this method due to the fact that stock holding costs increase as a business holds any of the above (raw materials and finished goods) for no good reason(Kirkham 2003).
Just in time technique calls for ordering raw materials only when an order of finished products has been made. This means that after production, the client who placed an order will be ready to pick his /her goods. This method was first applied by Japanese automobile manufacturers and is very effective in eliminating storage costs. A proper functioning coordination must be mantained between all the departments of the business. Miscalculations on when to create an order will lead to ineffectiveness among workers as they will remain idle for hours when they should be undertaking productive work for the business. Hence, strong communication from the respective managers will be of prime importance (Berliner 1988)
The greatest threat to sustainability of a business in is poor planning. We live in a world of abundant resources. These resources provide many opportunities for middle income enterprise like Worplestrop. However, without proper prioritization all these opportunities will remain untapped. Proper budgeting dictates some key decisions in business like the optimal level of production, strategies to eliminate costly spending mistakes identified in the past so as to streamline the business processes (Kirkham 2003). Worplestrop Partnerrship should evolve as a business unit. We must transform from a company selling goods to customers, to a service provider selling experience to customers. What experience does a customer get from patronizing our stores? Experience is memorable. The future lies in the experience economy.
With this in place, a functioning co-operation among leaders should exist so as to make everyday’s activity crucial in achieving long-term business goals of the firm (Horne 1999).