Manufacturers & Distributors ARTICLE -

Be Flexible: Use Standard Cost Budgeting to Control Your Expenses

Target Audience: Manufacturing and Development Companies, M&D Industry, Management Personnel, Strategic Decision Makers, Accounting & Consulting Firm Interest, Budgeters, Managers and Accountants

There are two ways for manufacturers to approach budgeting. They can assume their production will remain at set levels throughout the budget period and plan accordingly. Or they can develop standard costs to use in a flexible budget that can be adjusted to reflect actual production.

The smart choice is the latter method: standard cost budgeting. When you know your standard costs — what it should cost to make your products — you can identify why products end up costing more or less than you expected. Then you can take corrective actions as necessary.

Know Where You Stand

The first step in standard cost budgeting is to develop standard costs. At the beginning of each budget period, you estimate the labor, materials and overhead costs required to produce one unit of each of your products.

The assumptions you use to arrive at these figures must be reliable, because standard costs go on the books as journal entries. Make sure you’re working with current, accurate base data. When you’ve set standard costs, multiply them by the total number of units you expect to produce to develop your production budget.

See Where You Fall

At the end of the budget period, you’ll use a variance report to compare your budgeted costs to actual results. When you receive the results, resist any immediate inclination you may have to pat yourself on the back or mull over what went wrong.

For one thing, the total cost numbers won’t give you the reasons for variances. For another, you may find upon a closer look that one variance is offset by two other variances.

For example, let’s say your standard cost to make a widget is $350 per unit — $200 for materials, $100 for labor and $50 for overhead. It should cost you $175,000 to make 500 units, based on your standard cost.

It turns out, however, that your actual cost for 500 widgets was $178,000. This seems strange, because the actual labor cost was only $85 per unit, or $42,500, rather than the $50,000 you predicted in your production budget.

A closer look may reveal that your material costs went up to $220 per unit and overhead increased to $51. That made the total actual costs $110,000 and $25,500, respectively, instead of the $100,000 and $25,000 in your production budget.

The combined $10,500 variance in materials and overhead costs was enough to erase the $7,500 labor savings, leaving you with an overall unfavorable variance of $3,000. Of course, variances can also work to your advantage in any of several scenarios, such as one cost going down while the others are unchanged.

Find The Value

The true value of standard cost budgeting is that you can break each variance into its component parts to determine the cause. In the previous example, for instance, you may find that the price of steel increased significantly during the budget period, which boosted the raw material costs incurred to produce the widget.

There are a number of reasons variances may arise, but you can’t adjust for them unless you know the reasons. You also shouldn’t spend too much time worrying about very small variances. Instead, follow up only when variances reach a certain threshold.

Enlightening Effects

With standard cost budgeting, you and your managers can control costs more effectively. You understand not only where costs are changing, but why. That’s the type of insight that looks good on your bottom line.

Find out how our M&D accountants can add value to your business. Email us or call us at 1 (888) 875-9770.

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