Reasons for Cost Information.

One of the most important benefits of exact cost information is the application for pricing purposes. Although in practice prices are affected by many forces over which the manufacturer has little or no control, still good cost information is the basis an estimating system uses for pricing purposes. A company that has an intimate and accurate knowledge of its costs can base its price estimates on a sound foundation that will bring few miscalculations. A proper costing system will, in the long run, improve the company's competitive position within the industry. This may help explain the fact that today trade associations are trying to promote good accounting practices among their members, rather than emphasizing monopolistic activities, such as price fixing, as a means to increase profits.

Costs for Facility Profits

A proper cost information system also helps determine which machines or production centers in a plant are the most profitable. This is an important consideration, since it enables management to reflect this profitability in their sales emphasis. The product mix should maximize profits through the optimum use of all production facilities. It is possible that because of inaccurate cost information the sales emphasis may be placed on the less profitable products, thereby altering the economy of the company by misdirecting the sales effort. For example, if a company manufactures a product on expensive facilities, it is essential that enough units will be sold to justify the maintenance of these facilities. Otherwise, the company will find itself in the position of a poor investor, because the monies liberated by the sales will not provide sufficient return on its investment. Invariably this also results in tying up excessive capital in inventory. Therefore, instead of selling the time of his facilities, the manufacturer becomes a merchandiser of his raw material inventory, a condition that may well negatively affect his financial structure.

Costs for Make or Buy.

Cost information is also used in making decisions involving purchases and manufacture. With the help of a proper cost information system, a manufacturer can evaluate the desirability of maintaining or establishing a department as opposed to having the operations performed for him on the outside.

Costs for Optimizing Product Mix.

In a multi-product company, proper costs also help determine which products will be manufactured, according to the profitability with which the facilities can be operated in support of the product mix. A proper costing system also shows the relationship of profitability of facilities or products to the marketing costs required to promote and sell the product. In addition, costs allow the manufacturer to evaluate the profitability of his sales territories.

Costs for Long-Range Planning.

Good cost information is also essential for the planning of expansions, regardless of whether these expansions are physical or functional in nature. Proper costs will indicate where and when facilities should be added. If existing sales keep a major facility active 90 percent of its total capacity, the decision to add an additional facility to absorb a new sales drive using this type of facility, must be based on the cost of the inactive portion of the duplicated facility.

For example, an offset printing press costing $2,000,000 is productive 1,800 out of 2,000 potential hours, and there is no possibility of operating a second shift. A sales drive or contract requiring an additional 1,200 hours of this facility center is anticipated. To support these additional hours, management is faced with the purchase of a second offset press at the same acquisition price. The decision that management now has to make, since both presses operating together will provide 4,000 potential annual hours, is whether the company will make more profit with one press at 1,800 hours of activity, or with the 2 presses with 3,000 hours of activity. The impact of the cost of the 1,000 hours of inactivity of the two press operation must be considered. Unless management has sufficient cost data on which to base this decision, it is possible that they will fail to take advantage of a market opportunity, or may be committed to an equipment expansion that may limit future profit elasticity.

It is conceivable that the company may be faced with a greater loss or less profit at a higher sales level.

In planning for the long term, a company must know in advance the impact of a non-producing expansion, such as addition to sales offices or to administrative staffing. For example, how much more must be made in sales to justify the addition of a new executive, so that the company remains at the same dollar profit level? If a sales office is to be added, what will have to be the increase in sales to maintain the same financial position? If a company plans a price reduction in one of its product lines, what increase in sales will be required to overcome this reduction without disturbing the dollar profit level? If the company increases prductive or non-productive facilities, how much more vulnerable will it be to recessions as balanced against its opportunity for higher profits in boom times. Proper costs provide the basic information for making these determinations possible.

For example, in one company the addition of a $30,000-a-year executive require an increase in sales of $225,000 to maintain the same margin of do1lar profits, whereas in another company, in the same industry and with the same volume of business, an increase of $500,000 in sales may be required. The case may also be that one company can justify a 10% price reduction by an increase of 22% in sales, while another company in the same industry, also doing the same volume of business, may require a far different sales increase to justify the same reduction.

Costs for the Shorter Term.

For the shorter term, proper cost information, when separated into its fixed and variable elements, will give us the out-of-pocket and break-even point of specific orders and specific facilities. Having this cost information, a company is in a position to accept marginally priced work. In so doing, it is seeking to recover its out-of-pocket expenses, on the theory that its fixed sunk costs (depreciation and the like) are present irrespective of volume. However, discretion should be used in this case to avoid booking work which causes bottlenecks in the plant, or which occupies facilities at inopportune times when more profitable work is available.