Definitions for TrueValueMetrics
Cost ... What is cost?
Important that there is good understanding of what is cost, and what is price. If I am the buyer, then the price paid is my cost. If I am a seller, then the price paid is my price. Hopefully the costs are less than the price so I can make a profit. There are very little accessible data about costs. There is much more information about price, and it is price that gets reflected by 'markets'
Cost is a key metric ... while it is usually the subject of intense analysis within an organization, it is difficult for the public to get access to cost information. In the corporate for profit business, reducing cost is a way to increase profit ...other things remaining the same. Little is put into the public domain about costs ... but cost is a critical part of performance metrics both for determining money profit and also socio-economic performance.
Money Cost Money cost is what gets paid for someone to have a good or service. Money cost is also the use of resources to create a good or service ... the aggregation of all the elements of cost that go into creating something. Elements of cost are things like: labor; materials; operating expenses, admin and overhead expenses, depreciation and financial costs. In most good organizations, cost accounting is detailed ... and often very informative ... but also maybe overwhelming. Standard costs and variance analysis are methods that help clarify cost data, identify variations that need explanation and measure cost efficiency. Cost has multiple components, and one of the most useful data points for cost is the one that eliminates all the profit elements from the cost value chain. The socio-economic success of the last two centuries has been reduction in cost.
Cost accounting Cost centers, profit centers, investment centers, departments, etc are all rather similar. The key is to understand what they are doing and what they are costing.
If what they are doing does not seem to have any value ... then some further questions need to be asked and decisions made. Corporate accounting systems usually have very effective cost accounting capability, but getting useful information from these systems is not always obvious.
Elements of Cost Elements of cost help with an understanding of cost ... the behavior of cost. Business cost accounting has a focus on the costs that are integral to the business itself, and get reflected in the financial reporting to investors and other stakeholders. TVM value accounting goes beyond these financial costs to include everything that is used in the economic activities of the enterprise, bringing in all the elements that are sometimes referred to as 'externalities'. In the TVM framework if there is a change in value, there is a mix of value consumption and value creation which must be brought into the account.
Financial elements of cost There are several elements that make up the cost of anything. It is convenient to use the following categories to analyze the financial dimension of costs:
Beyond financial elements of cost In the TVM logical framework there are also these elements of cost or value change:
- 1. People cost
- 2. Material cost
- 3. Facilities and equipment cost
- 4. Operating expenses
- 5. Admin and general overhead cost
- 6. Financial costs
Drill down to elements of cost is important because the elements of cost all change in different ways ... have different behaviors ... and different impact on the community. The purpose of data in the TVM environment is to have data to understand ... and to use this understanding to improve decision making and the quality of life!
- 7. Cost of Profit
- 8. Consumption of social value
- 9. Cost of external constraints
People cost (1)
People cost depends on (1) how many people and what skills and job types; (2) the wage rates for each group; (3) the benefit costs associated with each group. The costing is complicated by matters such as training and the use of consultants and service contractors instead of direct paid staff.
People costs vary enormously depending on the mix of local and international staff. Local staff are usually paid much less than international staff. There might be a cost offset to the extent that international staff can do some work more efficiently than local staff due to their knowledge, training and experience.
Material cost (2)
Material costs are a function of a bill of material and the purchase price of the materials. A scrap factor should be included. Most production processes require more raw material inputs than there is output because of process losses (in machining, in casting, etc.).
Facilities and equipment cost (3)
Equipment costs do not behave in a simple way, and care must be taken in costing equipment use appropriately. Some of the characteristics that must be taken into consideration include (1) the life of the equipment in elapsed time; (2) the life of the equipment based on usage; (3) the utilization of the equipment in any given period; (4) the costs associated with running the equipment such as fuel and maintenance; (5) the cost of periodic major maintenance, etc.
In some cases, as for example, in using an aircraft for vector control, there are people and material costs that have variability depending on equipment utilization. All fixed assets have use costs that should be brought into account for costing.
Depreciation is a part of the cost framework. It is a concept that is derived from the economic life of an asset ... and in this context, nothing to do with tax law and allowable write-offs. The aim of depreciation is simply to relate the cost of using an asset to the activities the asset is used for. If an asset has a three year life, and is used most of the time, each of the year periods should be charged one third of the capital cost. This would give a reasonable result. On the other had an piece of equipment may have a life that depends on how much it is used (for example, an aircraft) ... say it will be useful for 50,000 hours of use. In this case the hourly cost can be computed and the asset charged to the activity for each hour it is used, and offset against the depreciation provision for the asset.
Operating overhead cost (4)
Operating overhead costs are costs associated with the supervision and management of operations. They are made up of elements of cost (1), (2) and (3) above, and allocated to specific units of activity.
Cost of capital employed (5)
Cost of capital employed is the cost of using fixed and working capital. It is calculated by reference to the investment made in equipment, buildings vehicles, etc (fixed assets) and the investment needed for material inventory, work in progress and finished goods, receivables and cash (working capital) that are used for specific activities. The calculation uses a cost of capital rate that varies depending on the ownership structure of the operation and the goals of this ownership. The cost to “rent” capital may vary from 2% to in excess of 200% per annum. This has become one of the most expensive aspects of modern capital market capitalism.
General overhead cost (6)
The general overhead cost is similar to operating overhead. It is made up of the same elements and allocated to operating activities o a basis that reasonably reflects the structure of the organizations and activities.
Cost of profit (7)
One of the biggest elements of cost in modern business is the cost of capital ... which is essentially the idea that profit becomes an essential part of the cost of product or service. In a system where the computation of (corporate) value is a function of the level of profit and the growth of profit ... then the profit behaves more like a cost than merely being the derivative of corporate performance.
Consumption of social value (8)
The system of money profit double entry accountancy was conceived over 400 years ago to help entrepreneurs (merchant adventurers) account to their investors or financiers. It is a very powerful construct but should be applied not only to those elements that impact money profit for investors, but also every single impact an economic activity has on society at large, including the environment in its broadest sense.
Cost of external constraints (9)
The analysis of economic activity must include the impact of what gets done today is having on the future. This used to be unimportant when economic activity was small scale relative to the community and the larger world. In the 21st century very large scale units of economic activity can materially change what is going on outside the bounds of the economic activity and must be brought into the accounting.
There are very little accessible data about costs.
Money cost is what gets paid for someone to have a good or service.
Money cost is also the use of resources to create a good or service ... the aggregation of all the elements of cost that go into creating something.
Elements of cost are things like: labor; materials; operating expenses, admin and overhead expenses, depreciation and financial costs.
In most good organizations, cost accounting is detailed ... and often very informative ... but also maybe overwhelming.
Standard costs and variance analysis are methods that help clarify cost data, identify variations that need explanation and measure cost efficiency.
Cost has multiple components, and one of the most useful data points for cost is the one that eliminates all the profit elements from the cost value chain.
The socio-economic success of the last two centuries has been reduction in cost.