Types of Costs in Business: How to Distinguish and Control Them

Any enterprise incurs costs: from the purchase of raw materials to taxes and deductions. Such costs exist not only in offline business but also in the online one, even if it’s a website with football stats or platform that allows users to play an online roulette game. Let’s see what types of costs there are and how the owner can manage them to the benefit of the business.

What Business Costs Are

The costs of a business are all of its expenses. This includes spending on materials, packaging, transportation, production processes, etc. They are recorded in the accounts, and they can be forecasted for a period of one day to several years. Costs determine the cost and price of the product, and ultimately the profit, which can also be influenced by securing financing from a private money lender in Singapore.

It’s impossible to get rid of costs completely, but you can control your costs. This will help both in pricing policy and in business development in general.

Why Calculate Costs

Controlling costs will help you increase profits. Knowing the amount and structure of costs means understanding how much it costs to produce a product or realize a service. In other words, to know the cost of the product. This is important both when planning the next steps and when assessing the current state of the company.

Without knowing the cost of the product, the manager cannot set the right price. There is always a risk of underpricing and facing losses, or overpricing and dropping demand. And costing protects against these risks.

Cost control also makes planning easier. Knowing what expenditures you make on a regular basis can give you an idea in advance of how much you will need in the next period.

Types of Costs

Recurring

Costs that the business makes regularly. For example, office rent, salaries of administrative staff, communication, and internet fees. Fixed costs don’t depend on production volumes or revenues; their volumes remain at the same level for a long time.

Fixed costs are calculated to reduce the risk of cash flow. If there is always money in the accounts for monthly debits, the risk of a gap is greatly reduced.

Variable

Costs that are directly related to production or sales volumes. They include costs of raw materials, packaging, transportation, salaries of pieceworkers, commissions for sales, expenses on delivery of goods to customers, etc. As production volume increases, variable costs increase.

Direct

Costs directly related to the creation of a product or the realization of a service. That is, those expenses without which the manufacture of the product or provision of the service would be impossible. These are the costs of materials, equipment, packaging, and the wages of production workers.

Direct costs must be known to calculate the cost of goods or services. And knowing the cost price, you can predict profit and profitability.

Indirect

Costs that cannot be directly related to a specific product or service. They are common to the entire business and cannot be accurately attributed to certain costs. These are the costs of administrative staff, rent for shared premises, marketing and advertising, and outsourced accountants.

Calculating indirect costs can help with tax optimization. If a company keeps accrual accounting, the more indirect costs it has, the less tax it will pay in the end.

Production

Costs on which the process of production or provision of services directly depends. In addition to the purchase of raw materials and salaries of production workers, these include the costs of maintaining production (energy, equipment, depreciation, and amortization) and delivery of orders.

Non-production

Costs that aren’t directly related to production. They may be related to administrative activities, sales, marketing, management, etc. For example, office stationery, advertising, or renting space in a warehouse. Without them, the business will face difficulties, but production itself won’t suffer.

Explicit

Those costs that the enterprise has incurred officially, according to documents. That is, they are costs that are clearly reflected in the financial statements and can be easily measured. For example, costs of materials, rent, salaries, insurance premiums, etc.

This includes all expenses from the above categories.

Implicit

Costs that aren’t reflected in the financial statements and cannot be accurately measured. They are also called opportunity costs because they are formed from the profits that the business could have made but didn’t. For example, losses from poor quality production, losses from inefficient use of resources, etc.

How to Plan Costs

Cost planning allows a business to optimize its expenses. Simply keeping in mind how much a business will spend next month is inefficient. For financial performance to be predictable, it’s important to follow certain rules:

• Planning should cover different lengths of time. It would be strange to make a plan for the year but not break it down by month. Try to visualize what financial transactions the business is expecting in the next week, month, and year.
• Plans should be made based on accurate data that already exists. You can check their accuracy by checking the numbers in the three main reports: Profit and Loss Account, and Balance Sheet. The margin of error shouldn’t exceed 5%.
• Cost planning needs to be systematic. First, set a goal and determine what costs need to be planned. Then, select the necessary tools: these can be Payment Calendar and different types of budgets.

How to Reduce Costs

Cost reduction can be achieved in a variety of ways. Here are the main ones of the methods.

Reduce Variable Costs

To do this, you need to analyze your production and sales processes and find opportunities to optimize them. For example:

• Find a supplier with a more favorable offer.
• Look for alternative sources of raw materials.
• Improve the efficiency of resource and technology utilization.
• Improve inventory management and reduce losses.

Reduce Fixed Costs

• Consider outsourcing. For example, a start-up business doesn’t always need a designer and lawyer on staff. It may be cheaper to go to agencies or freelancers.
• Reconsider the terms of the lease. At the first stages, renting equipment may be more profitable than buying it, especially if it often breaks down. You can also analyze whether you really need the exact space you are renting. Perhaps a smaller space or a different location will work.
• Optimize processes. You can rethink pay and employee responsibilities. It makes sense to think about automation as well, take corporate travel for example, you can manage this process more efficiently by using online platforms to keep a close eye on travel expenses and to ensure compliance with company policies.

Reconsider the Approach to Doing Business

• Change the product mix. You can compare the cost of production and the volume of sales in this area. Accounting services will help here. 
• Analyze and optimize marketing and advertising costs. 
• Optimize work organization and rationalize work schedules. Perhaps some departments are overloaded with work, and some sit for days without tasks.
• Use innovative approaches and technologies to reduce costs.

Cutting costs isn’t always the best move for a business. Sometimes it can even be profitable to increase costs. The entrepreneur’s task is to know and control his costs, not to reduce them at all costs.