Doing any business involves certain costs. One of the basic laws of the market is that you need to invest something in order to get something. Even if an organization or an entrepreneur sells the result of its own intellectual activity, it still incurs certain costs. This article discusses what are the costs, what they are, the differences between external and internal costs, as well as the formulas for their calculation.
What is the cost?
This concept is applicable in all areas of business. Costs are the organization’s expenses for its needs, production activities, utility bills, employee salaries, advertising costs and much more. External and internal costs, their correct calculation and analysis - the key to stable activity and financial security of enterprises. In the process of conducting business, it is necessary to take a sober look at the capabilities and needs of the organization, optimally select the set of purchased services and products, trying to minimize expenses and maintain their level below the level of profit.
Terminology, or What are the costs called?
Economics is a science with a very large number of branches, each of which studies its individual phenomena. Each direction has its own methods of collecting and processing information, as well as methods of documenting the results. Due to the large number of various reports used by different specialists, but carrying essentially identical information, there is some uncertainty in the terminology. So, the same phenomena can have completely different names. So, in different types of documents, internal and external costs can be found under different names. These items are presented below:
- accounting and economic;
- explicit and implicit;
- overt and imputed;
- external and internal.
By nature, all these names are identical to each other. Acquaintance with this fact will allow us not to get confused in the future when processing various documents in which these names are found.
External costs are ...
The organizations in the course of work purchase raw materials, materials, machine tools and equipment, pay the labor of maintenance personnel and staff of specialists, pay utility bills for consumed water, energy, use of the land plot or the area of ​​office buildings. All these payments are external costs. This is a disposable part of the organization’s cash in favor of the supplier of the necessary product or service. In this case, the supplier is a third-party organization that is not related to this company. Also, these payments may be referred to in different documents and reports as accounting or explicit costs. This all has one characteristic feature - such payments are always reflected in accounting records with an exact indication of the date, amount and purpose.
Internal costs
It was considered above what external costs are. Economic costs, they are internal, implicit or imputed - the second type is taken into account in the reporting and analysis of costs. Everything is a little more complicated with them. Unlike obvious costs, this is a waste of one’s own resources, not a purchase from a third-party organization. And the amount that is considered in this case expenses is the amount that could be received by the organization if it used the same resources in the most optimal and profitable way. The use of this type of expense is not used in accurate and documented accounting. But implicit costs are actively operated by economists, whose tasks include evaluating the effectiveness of the organization for past periods, planning and compiling business models for future production processes, as well as optimizing all areas of business activities.
Subspecies of External Costs
The production process requires investment in its various components, without which the mechanism of production or the provision of services simply would not function. The external costs of the company are classified depending on how their price will fall on the final cost of the product or service provided. The distinguished types of external costs are:
- Fixed costs - expenses, the amount of which in equal shares is included in the cost of a product or service over a certain period of time. They do not change from increasing or decreasing production volumes. An example of such costs is the salary of employees in administrative positions, or the payment for renting an office, warehouse and industrial premises.
- Average fixed costs are expenses that also do not change over a short period of time. However, in the case of average fixed costs, the dependence on the volume of output or services performed can be traced. With a larger volume, the cost of production decreases.
- Variable costs - costs that directly depend on the volume of output. So, the more goods were manufactured, the more it is necessary to pay for raw materials, labor of workers receiving piece-rate wages, and the supply of energy resources.
- Average variable costs - the amount of money spent in paying variable costs for the production of a unit of production.
- Total costs - the result of the addition of fixed and variable costs, reflecting the overall picture of expenditures on the functioning of the organization and production activities for a certain period of time.
- Average total costs - an indicator of how much money from the total amount of expenses falls on one unit of output.
Features of variable costs
What costs are called external variables? The volume of which varies with the volume of production. Only fluctuations in the amounts of variable costs are not always linear. Depending on the cause and method of changing production volumes, costs can vary in three predictable ways:
- Proportionally. With this type of change, the amount of costs varies in equal proportion with the volume of production. That is, if a company produced 10% more products in a given period, costs also increased by 10%.
- Regressively. The amount of costs spent on the production of products is growing more slowly than the volume of production. For example, a company produces 10% more goods, while costs have increased by only 5%.
- Progressively. Production costs are growing faster than production volumes themselves. That is, the company produced 20% more products, and costs increased by 25%.
The concept and significance of the period in the calculation of costs
Any calculations, analytical and reporting activities, as well as planning, are impossible without the concept of a period. Each organization develops and operates at its own pace, so that a clear time period, the same for all firms, does not exist. The decision about what time period to use as the reporting period is made in each specific organization. However, these figures are not taken from the void. They are calculated depending on many external and internal factors.
Time is a factor that is of great importance in calculating profits and expenses. Analysis of the growth of production activity or its deterioration, profitability or loss-making can be carried out only on the basis of its totals for several reporting periods. Data are usually considered separately for the short and long term.
Long-term and short-term costs
The short-term period may be different in duration for organizations of various industries. General rules for its establishment - in the short term, one group of production factors is stable, the other can change. The land, production areas, number of machines and units of equipment remain constant. The number of workers and their remuneration, purchased materials and raw materials, and so on, can change.
Long-term planning is characterized by the adoption of all factors of production and their costs by variables. During this time, the organization may grow or, conversely, decrease, change the number and composition of employees in the staffing table, change the actual and legal address, purchase equipment, and so on. Long-term planning is always more complex and deeper. It is necessary to predict the dynamics of development as accurately as possible in order to stabilize the company's position in the market.
Cost formula
In order to find out how much money the organization takes to maintain production activities, there is an external cost formula. It is depicted as follows:
- TC = TFC + TVC, where:
- TC - an abbreviation of the English language - Total Costs - the total cost of production and the functioning of the organization;
- TFC - Total Fixed Costs - the total amount of fixed costs;
- TVC - Total Variable Costs - the total amount of variable costs.
In order to find out the amount of external costs per unit of goods, an example of the formula can be given as follows:
- ATC = TC / Q, where:
- TC - total amount of expenses;
- Q - the volume of goods released.