Standard Costs... What are they good for...

Standard costs what are they good for, absolutely nothing say it again... Ha ha, no no no... a lot actually, got caught up in old songs.

Standard Costs are great for setting a bar to see where you are at, and where you want to be.

As an accountant a standard cost is very helpful for many different teams within your company.

Pricing, Sales, Manufacturing, Marketing, Operations, Senior Executives, leadership all over. Even Human Resources.

Whatttt!!

Yes I can connect cost accounting to all of these.

But in my mind I will start with the top of the food chain, and we will discuss sales and pricing.

In your company this could be one in the same, but in mine we separate these two functions to keep this in a four eyes principle, so that we are keeping a good eye on our margin.

So where does Standard Costing come into play. Glad you asked

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Standard Contribution Margin

Contribution what? Yes Standard Contribution Margin, just another word for us accountants to talk about Sales minus Standard Costs. I won't go deeper into different types of words for sales, some may know it as revenue, and then there are consolidated and unconsolidated... We can get into that in a further discussion.

Back to margin. Standard Contribution Margin is when you are taking your Revenue, and then you are selling products, and taking the cost at a standard calculation.

Let me share an example:

Lets say Apple is selling iPhones. They sell want to know what price to sell these at. Lets say the cost to produce each phone is $400.00. Generally they will know how much their fixed costs are, and lets say that this is 30%.

Everything is random here, as a disclaimer, I do not work for Apple, and I have no idea how much things cost for them. Anyway... lets say they want to make 20% profit, working backwards, we know that they would then need to sell their phones at $800.00 per phone in order to make the target profit.

That is so simple.

If only that were true. What complicates things become many different factors within selling. As Apple does not only sell an iPhone, they have many different products, and many different things to consider within costs.

Machinery, factories, customer demand, technology to build the desired products, and many more things.

But if I can determine how much each item I sell costs on average, then it allows me to set a price.

But what are some driving factors that may drive price increases or the like. I'm glad you asked. Pricing and sales are interested in several things

Labor

The cost of labor is an important thing. Especially depending on the industry you are working in. If I work selling hand crafted shoes, then the amount of money that I pay my employees is going to have a significant impact on the cost of my shoe. If there is high inflation, and I need to pay my employees more in order to keep them, then I need to know how this will affect my cost.

Knowing how this will affect my cost, will also allow pricing and sales to understand how the margin will be affected. This will show if they need to do a price increase in order to maintain proper margin

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Raw Material

Recently there are major events that had contributed to the increase of prices in Raw Materials. COVID-19 is a perfect example of things like scarcity driving inflationary measures. Generally what happens is when the expectation of a raw material price goes up, when you rerun the standard, you can see how this will affect your product.

Especially something like steel prices can greatly affect your pricing if you are selling something like a car. Or even tariffs on raw materials can also affect the pricing of your material.

It is imperative for pricing and sales to understand how this is going to affect the cost of the product. Several things can occur, they don't want to be slow to their competitors to offer a price increase. Either the have opportunity cost from not raising it quick enough, or if they are slow compared to their competitors, raw material pricing can be a permanent increase and they will never be able to increase the price, or if they are late and they do, then it will negatively affect their volumes.

Working closely with Accounting to understand the effect on costs is very important

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Freight Costs

Another major impact of COVID was freight costs. A container to ship from China to the US during the pandemic at times more than tripled in cost due to short supply of containers. Because of this there was also inflation, driving up prices as well.

These are also easy to be monitored if your company has a robust Cost Accounting program in place.

In Conclusion...

It is very important to have a good understanding of the cost components of your products, so that you can react quickly to the changing market and landscape of business. It is also important to have good ERP to maintain this. Especially for larger companies where stock prices can depend on hitting earnings estimates within 1% a good handle on something like a 5% price increase can be the difference between hitting your target, or tanking and seeing your stock value slip.

This can impact many things like cost to borrow money, or even being able to take advantage of new opportunities in the form of partnerships. People want to invest in smart companies. Smart companies make smart decisions and if you are selling tangible products, you need to have a handle on your costs.

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