Cost Drivers
Cost drivers play an important role in allocating costs within an organization. They are used to explain and measure the economic cause of costs and are necessary for cost allocation decisions and for preparing budgets. Organizations utilize cost drivers for decision making and cost control.
Cost drivers are variables that cause costs to increase or decrease. These variables can include capacity, complexity, quality, labor hours, or materials. For example, if an organization increases its production capacity, this will lead to an increase in its overall costs; therefore, capacity can be considered as a cost driver.
Businesses can use cost drivers to identify cost savings and inefficiencies. For example, if an organization is using more materials than necessary to produce its products, this can be identified by using cost drivers to calculate costs per unit. This analysis can help the organization identify areas for cost savings and reduce unnecessary costs.
Cost drivers can also be used to analyze customer profitability. Many businesses use customer profitability analysis, which measures the profitability of individual customers by calculating the costs associated with sales and services for each customer. This analysis helps businesses identify customers that are generating the highest profits, and therefore should receive the most attention and resources.
Cost drivers are also used to calculate the cost of capital. The cost of capital is a measure of the overall cost of financing a business, including interest rates, debt levels, and equity costs. Calculating the cost of capital can help a business make informed decisions about financing, such as which type of financing is most appropriate, and how much money to invest in a particular project.
Finally, cost drivers are used in activity-based costing and budgeting. With activity-based costing, businesses can allocate and assign costs to specific activities based on cost drivers. This information can be used in budgeting, as it allows businesses to estimate the costs associated with specific activities.
Overall, cost drivers play an important role in decision making and budgeting. They are necessary for understanding the economic cause of costs and allocating costs in an informed way. Cost drivers can help businesses identify cost savings and areas of inefficiency, analyze customer profitability, and calculate the cost of capital. Additionally, cost drivers are used in activity-based cost analysis to facilitate informed decision making and cost control.
