Understanding the true cost of your products

August 26, 2013

2 Min Read
Understanding the true cost of your products

What does it cost to make a single bag of granola, a box of cereal, a protein bar, etc.? Do you know what it costs to produce one sellable unit of your product? While most natural companies have a pretty good idea, they don't have a good strategy to account for the volatile pricing of some ingredients. This can cause brands to over or under estimate their expenses.

Cost accounting

The cost of an item goes well beyond totaling its ingredients, adding your labor and packaging. Knowing the true cost of an item is critical to help you identify your true profit margins, especially during a promotion. This can help you better manage costs and keep them under control. Paying close attention to ingredient prices and market conditions can also help you predict pricing fluctuations, giving you an opportunity to schedule purchases to take advantage of optimal pricing opportunities.

This is called cost accounting. While this is not traditionally a category management function, it is crucial to help you determine the profitability of a promoted item.

Business owners should be comfortable with the term "cost of goods sold," which is calculated by subtracting your total sales (income from the sale of your branded products) from your expenses. Cost accounting is an advanced accounting discipline that focuses on identifying the true cost of an item. It drills down to the cost of the glue required to hold the chair together or the cost of refrigerating a single pint of yogurt for one hour. The more granular your understanding of your costs, the better you will be able to manage them. This will also help you average those costs to account for changing market conditions. Then when an ingredient price increases, you won't be blindsided.

Small manufacturers don't typically apply this level of sophistication to product costing. They include the entire bottle of glue and all of the utilities as lump sum totals in the fixed expenses section of the income statement. This strategy doesn't give you good insight into what it actually costs to produce your products. It can confuse costs as your sales increase, leading you to misrepresent your cost of goods sold. This becomes a bigger issue when you try to calculate your margins and when you work to place a value on your company.

From a true category management standpoint, this can directly affect your ability to compete effectively. A misstated cost can cause you to improperly price your products, especially when promoted.

What strategy do you use to manage costs and drive margin?


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