The Definitive Guide to Business Finance: What smart managers do with the numbers, Second Edition

How managers assess costs

So far, we have discussed mainly the accountants’ concept of cost allocation – with some lip service to economists. However, one of the most valuable assessments you can make is a review of costs by product or service. And for each item, you also need a breakdown by activity – development, production, sales, etc. You can then set these figures against revenues by product to see how your lines really stack up.

But how? Traditional cost accounting falls down in some areas. Its approach to direct product costs is fine, but it then assumes that indirect costs are allocated to products in some arbitrary way. The most usual method is to say that this product generates 20% of our revenue so we will assume that it absorbs