Sales and costing definitions and models
Understanding where we are and how costs behave, for example direct costs compared to indirect costs or overheads, is essential.
You can model and predict the future (see Chapter 10 on budgeting and forecasting) but as Sir Mervyn King belatedly identified, 'the future is unknowable' (lunch with the FT, 14 June 2013). Modelling possible income and costs structures often plays a key part when identifying and understanding options in order to select the most advantageous strategy.
Common types of models
1 Sales models.
2 Costing models:
- costing for planning;
- costing to calculate full costs;
- costing for control.
We often mean sales forecasting models with the ability to be adjusted up or down for growth or decline in sales from some median position. Sales models will really be sales forecasts and budgets. Management accounting for sales is a strategically vital model - if we but knew what sales would be tomorrow, never mind next year, we could optimize our operations.
Costing models - definitions
Direct cost A cost which is clearly and identifiably related to a product or service being sold. A direct cost is one which is not shared between two or more activities but is directly related to the product, project, process, service etc being costed.
Indirect cost or overheads A cost which cannot be easily, or at all, related to the product, project, process, service etc being costed. It is a cost which often has to be shared between two or more activities - it has to be allocated to, apportioned to or absorbed into the product, project, process, service etc being costed, along with direct costs, to give a total or full cost. Indirect costs are often called overheads.
Variable cost A cost which varies with the product, project, process, service etc being costed. It is a cost definition used in costing for planning, sometimes called marginal costing. As a starting point, in planning exercises it is assumed that a variable cost will vary in direct proportion to changes in output - that is, if 1kg of material costs $3 then 4 kg will cost $12.
Fixed cost A cost which is fixed in amount for a particular time period and over a range of activities. Overhead or indirect costs are often fixed in nature, for example the rent of a retail outlet will be fixed for, say, one year at least, no matter how many items are sold from the outlet. The rent could be increased next year, or a larger outlet would presumably increase the rental charge. Fixed costs can be variable!