How to do a cost analysis in six easy steps!
Cost analysis is very important for your business and it is a procedure you will need to set up at various levels of business development.
Whenever you want to invest more in your business, you need to make a cost analysis.
If you want to expand your business, open a new unit, test a new market, you'll need a cost analysis.
If you want a loan from the bank, you'll need a cost analysis. And if you're looking for some angel investors, you guessed it right... A cost analysis is a must.
But how do you do one? Read on for all the steps..
Here are the six easy steps for creating a cost analysis:
Step #1: Determine the specific type of cost you're evaluating;
Step #2: Calculate your current operating costs (this is how much it costs you to run your business as it is);
Step #3: Calculate your current profit;
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Step #4: Work out your new operating costs (this is how much it will cost you when you make changes to your business);
Step #5: Calculate the new profit; and
Step #6: Evaluate which option is more profitable.
As a useful tip, make sure all your calculations use the same time period e.g. per month or per year.
Here's an examplethat proves why a cost analysis is useful:
This example shows how cost analysis helped this business choose the right purchasing option
Xolani and Mike's company manufactures leather shoes near Cape Town. They bought a shoe manufacturing machine which they call 'Suzy'. They've decided to look at buying a new shoe manufacturing machine. A salesman offers them an option of two new machines to consider purchasing. Each new machine will increase the current number of shoes manufactured.
The first new machine is the 'Terminator'. It costs R1 110 000. The second new machine is the 'Gorilla'. It's cheaper as it costs R908 000.
Mike wants to buy the 'Gorilla' because it is cheaper.
But, Xolani wants to keep the 'Suzy' because he doesn't want to pay for a new machine. They have a decision to make to benefit their business.
They need a cost analysis to see if they should replace the 'Suzy' machine. The cost analysis will show which machine will benefit the business.
Caution: You can't just make a purchasing decision based on price alone. It may be cheaper to purchase something upfront; but more expensive to run it in the long run. You need a cost analysis to account for all associated costs (support, maintenance etc.)
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