Understanding expenses is a crucial aspect of accounting. Small business owners would never know whether their company is profitable if they don’t know how to get hold of their spending. This is where cost accounting comes into play.
It focuses on a company’s cost structure and helps businesses get a detailed insight into how their money is being spent. Through this tool, the management can gauge how much a business is earning, losing and spending, and thereby make more effective decisions.
What is cost accounting?
Investopedia defines cost accounting as “a form of managerial accounting that aims to capture a company’s total cost of production by assessing the variable costs of each step of production as well as fixed costs, such as a lease expense.” It is not compliant with GAAP and cannot be used on official financial statements, but rather only for internal business purposes.
In short, cost accounting examines the cost structure of a business by collecting cost information with the aim to improve profitability as well as efficiency.
What are the different types of cost accounting?
Various techniques are used to perform cost accounting, depending on the management or leadership team. Listed below are the four primary types of cost accounting.
Standard costing: This entails assigning “standard” costs to materials, labor and overhead evenly. Thereby helping managers to plan budgets and control costs more efficiently.
Activity-based costing: This involves assigning indirect costs, popularly known as overhead costs, to each activity in the production process. Thereby giving businesses a better understanding of the production activities and the associated costs.
Lean accounting: This is a more conservative form of cost accounting that is designed to streamline accounting processes to maximize productivity and quality, and eliminate unnecessary transactions and systems.
Marginal costing: This reveals the incremental cost that comes with producing additional units of goods and services. Thereby helping businesses identify the most efficient level of production.
By being aware of the total costs associated with production, small business owners can easily identify instances of vendor overcharging, and could also be able to learn about efficiencies that enable them to save money.
One of the major benefits of cost accounting is that it aids business owners in better understanding their profit margin and the factors that influence it. Additionally, it helps in budgeting and financial forecasting, cost control, cost allocation, cost savings, and making quick and informed decisions based on accurate calculations as well as market assessments.
How can small business owners use cost accounting to their advantage?
For any small business to be successful, the owner and the leadership team need to understand the economics of their business’s operations; and cost accounting can be a powerful tool to obtain key insight into operations and boost the overall profitability of the business.
Listed below are a few ways in which small business owners can benefit through cost accounting.
Improved business efficiency: By examining the expenses associated with producing a specific product, cost accounting enables small business owners to make improved production, pricing and operational decisions.
Increased profitability: Through cost accounting, small businesses can assess their financial performance, spot areas for improvement and create strategies to boost profitability.
Better financial forecast: By creating projections and budgets, cost accounting offers insight into future cash flow and expenses.
Reduced expenditures: A thorough study of the expenditure is the most efficient way for small businesses to cut their costs. Hence, with the help of cost accounting, small business owners can identify the unnecessary spending which can be reduced.
Better allocation of resources: Small businesses can assess the effectiveness of different divisions and departments and decide how best to allocate resources with the help of a cost accounting system.
The bottom line
When using cost accounting, small business owners should ensure that they pick the right cost accounting system. Besides, in order to lower their business accounting costs, they need to separate business expenses from personal expenses, track and analyze data on a regular basis, maintain accurate records, invest in good software (if required), monitor invoices, keep an organized inventory record, and most importantly make sure that their budget is aligned with their long-term business goals.
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This material has been prepared for informational purposes only. Escalon and its affiliates are not providing tax, legal or accounting advice in this article. If you would like to engage with Escalon, please contact us here.