Cost Drivers: How much money do I need in my metalworking company?

"Cost drivers" also known as inducers or cost factors are the direct cause of a cost and their effect is on the total cost incurred.

Although it is important for any organization to present profits, it is also important to know the costs of products and services to optimize the information in making strategic decisions such as pricing, cutting costs and expenses, and implementing new machinery and technology, as well as establishing the prices for economies of scale, among others.

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Costing systems allow companies to have knowledge about how much money is necessary to invest to carry out a cost object, which can be: a product, a process, a service, or something that you want to know its cost. These systems have evolved through the improvement of technology and the competitive growth that is observed in any economic sector, resulting in greater accuracy in the value of costs.

Application of cost drivers in calculating the cost of a product

In a metalworking company, the main determinant of whether there will be continuity or discontinuity is cost. If the cost of production exceeds the income derived from a sale, there is a high probability that the business will end; on the other hand, if the costs are less than the income, there are profits and a probability of expansion. If costs equal revenues, then the business is at a point of indifference and can be closed or continued depending on variables other than costs.

To make decisions rationally, you need workable costing methods to get the cost right, or a figure close enough to the actual cost that you can do a reliable cost/revenue analysis.

Keep in mind that the total costs of production are used to establish the selling prices of particular products. Therefore, if these are inaccurate, the earnings forecasts will not be accurate and the entire accounting system of your company will be subject to errors.

The costs of your metalworking activity can be assigned to a particular production lot, and this makes activity-based costing an accurate way of allocating direct and indirect costs. It is a method of calculating costs associated with each product or production line in a company based on the number of resources consumed by each activity.

For example, most operations use machines, and, therefore, the machine hours used tend to determine the total cost of operating the machine based on how much money is charged per hour. If a person operates a machine for 5 hours for $5 per hour, then the total cost to be charged at the end of that particular time is $25. The more hours of labor used, the higher the cost.

If the particular machine we are referring to requires a maintenance cost of $1,000 after operating for 2,000 hours, then the maintenance cost for each hour of machine operation is 50 cents ($1,000 / 2,000 hours). Therefore, machine hours can be classified as a cost factor.

Another factor that determines the total cost is the cost per labor. If it is high, then the cost associated with production will also increase. Indirect costs associated with a production line, such as quality control costs, are distributed based on the ratio based on the products that were subjected to this control.

In general, any untraceable cost should be subtracted from contribution or operating profit, but should not be assigned to individual products without any rationale.

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This means that anything that determines the total cost of a particular activity must be thoroughly analyzed to ensure that an appropriate allocation base is used. Cost generators, or cost drivers, follow a cause-effect relationship, and if the relationship cannot be established, then a more relevant driver must be sought.

When making a medium and long-term business projection, it is essential to understand how our cost will vary due to what has been previously reported, if the cost is greater than the income, then the activity is not sustained. This is why we must ensure that the cost goes down, or at least does not go up.

In countries such as Latinamerican countries that suffer from a certain macroeconomic instability, it is essential to monitor the variables that determine costs (the dollar, the price of commodities, union salary agreements for each activity). Monitoring these variables and understanding their behavior in our cost formation is essential to have an alarm system that, as soon as one of these variables exceeds what was planned, warns us that we must take some particular measure so as not to lose track of the company's profitability objective.

Conclusion

A cost driver is the most appropriate way to calculate or determine a specific cost.

The variables that affect costs depend on the type of activity, and monitoring them is essential to making the right decisions at the right time.