Cost Drivers Examples In Service Industry

The textbook answer defines cost drivers as those factors that determine the overall cost of. As an example, in manufacturing the cost drivers may be processing time or number of steps to produce the product. In service, the cost drivers could be the actual ratio of billable to non-billable time. Or it may simply be the actual compensation package cost for labor.

The key is that this cost driver is used to allocate the general overhead and administration costs through Activity Based Costing (ABC Costing). But this article isn’t about the textbook answer; it’s about understanding what drives costs in the small business world. Sometimes it ends up being the textbook answer, but most often it is some common denominator with the company that prohibits greater profits. I’ll give you a simple real life example.

The current accounting literature is filled with activity based costing ABC~ articles about cost drivers in manufacturing settings but very few examples of cost. A cost driver rate is the amount of indirect or variable cost assigned to each unit of cost driver activity. For example, you may apply indirect overhead to direct labor hours as $50 dollars per hour.

Ray’s Auto Repair Back in the 90’s I had a client named Ray. His wife ran the office of the auto repair shop. He had four bays and four mechanics and was open five days a week. At the end of each month they barely made enough money to survive. So he asked me why he’s not making more money. His labor rate matched the competition and he had plenty of work. After several years of going there and interacting with him and his wife it really wasn’t hard to figure out.

Sometimes the obvious is ignored. First, he didn’t have enough bays to process the volume of work necessary to generate enough gross profit to cover his general operating costs. Why do you think Firestone and Goodyear facilities have no less than 10 bays? In addition they are open seven days a week. A common discussion issue with my visits related to the inability of the mechanics to get the work done quickly. Somachine rukovodstvo po programmirovaniyu menu. It was always the same issue, lack of experience or training. Here in this small business, what drove the cost up as a percentage of revenue were these two cost drivers.

This is what I mean by cost drivers in the real world of small business. To understand cost drivers I’m going to first explain the relationship of cost drivers to profit. How brands grow sharp. Next I’ll attempt to teach you how to evaluate your business and identify the cost drivers.

Finally an economic lesson in controlling cost drivers to enhance profits is illustrated. So let’s begin. Contents • • • • Cost Drivers and the Impact on Profit The key to cost drivers is understanding their relationship to profitability. Always look at cost drivers in the here and now and not in the ideal world. The reason for this is because as you determine the current cost driver and then control this cost driver, a new one will take over and you’ll have to begin the process all over again. Basically it is an ongoing never ending process for continuous improvement.

You don’t need to do this every day, but it should be a part of an annual self-evaluation. Allow me to illustrate this relationship in a simple business operation. Suppose you owned a hot dog stand. What do you think drives down profit? Notice I didn’t say what drives costs?

This is because the term cost drivers is the industry term used but in reality it should be referred to as profit dampening or profit reducers. But I’ll stick to cost drivers because this is the universally accepted terminology. OK, back to the question, what drives down profit? For the novice businessman he’ll say it is the cost of food or maybe not enough revenue associated with the sale of the hot dog. Me, I would say weather! I know, you are asking the question, ‘How do you derive at weather as the cost driver?’ Allow me to explain. Let’s suppose you have the perfect spot for the hot dog cart.