Economic and Cost Analysis - Types of Cost

In simple terms, cost means the amount of money that you need to make or do something. Here the meaning of the cost is the total amount of money that one needs to spend for a business.

Synonyms of the cost are expenditure, expenses, payments, price, fee or charge etc., which are also the terms used regularly in the business world. One should face different types of costs starting from setting-up of business to its final establishment.

Basically business costs are divided into two categories they are fixed cost and variable cost. However they are various costs which would be surfaced during the course of business and such cost should be borne by the owner. Various cost of the business are as follows:-

Importance of Economic and Cost Analysis

Economic and cost analysis is used to make financial decisions. Financial decisions are part of everyone's life, whether you are a student, teacher, parent, manager, engineer, technologist, or health professional. Some examples of economic and cost analysis in use are:

  1. Buying a new house

  2. Using credit cards

  3. Leasing or buying a vehicle

  4. Traveling on vacation

  5. Getting a bank loan

  6. Hiring new employees

  7. Buying new equipment

  8. Replacing a machine

  9. Investing in a new facility

  10. Building new bridges and roads

As mentioned earlier, economic and cost analysis can affect everyone's life. This science can be used to solve real-life problems in the business world. This science can help to make the correct decision depending on facts. The future and its factors are taken into consideration to reduce uncertainty; therefore, making managers more confident about making decisions for the future. Using the tools of economic and cost analysis enable us to understand and reduce the complexity of real-life problems. It leads the way in predicting, optimizing and controlling the respective systems. The use of economic and cost analysis helps industry to optimize more and more complex systems with more and more constraints. Finally, yet importantly, it provides powerful support for business decisions.

Actual cost (outlay cost or acquisition cost or absolute cost): cost which is incurred by the firm while producing the goods. eg: cost of raw material, labour, power

sunk cost: Sunk costs are unrecoverable past expenditures. These should not normally be taken into account when determining whether to continue a project or abandon it, because they cannot be recovered either way. It is a common instinct to count them, however.

ex: when TATA MOTORS had set up the nano plant in west best Bengal. Subsequently it faced lots of protests by the local farmers of that area as they felt that the nano plant may pose a threat to their farmland, consequently it had been shifted to Gujarat, bearing huge loss.

Similarly, a firm may have spent towards Rs 10,000 in connection with its proposal to purchase a new machinery at a price of Rs 1,00,000. Later, suppose, it is offered another machine, of equally good quality, for Rs 70,000. The amount of Rs 10,000 spent in connection with the first proposal is a sunk cost. It will no more be a decisive factor in deciding whether the second property has to be acquired or not. To understand this better, consider the alternatives available for the firm, that is, to favour the first proposal or the second one. If the firm proceeds in favour of the first proposal, , it will have to pay a price of Rs 1,00,000. If the second proposal is favoured, it will require an expenditure of Rs 70,000 only. These are the relevant costs for decision. The purchase of machine under second proposal results in a direct saving of Rs 30.000.

Implicit cost or imputed cost: (cost that is implied but not reflected in the financial reports of the firm). Cost which belong to owners or to the owners himself. Cost which does not include cash payments to the outsiders, it will remain in the form but showed as cost to the firm Eg: Rent on own building, interest on own capital.

Explicit or paid out cost: Cost which are actually paid by firm to the outsiders. Expense that is contractual in nature and definite in amount, such as rent, salaries, wages

Book Cost: Cost which does not require any cash payments to the outsiders, but is treated as cost to the firm.

Eg: Depreciation on assets.

Economic cost or future cost: These costs relate to the future. Expected to be incurred in some future period. Eg: Cost may incur by introduction of new products in future or expansions of firm

Social cost: Cost which is happened for the aspects like pollution control, cleaning purpose, cost incurred for the welfare of the people.

Indirect Cost: Cost which are not easily traceable in the production process. Eg: Wastage of Raw material, Electricity bills.

Controllable Cost: Cost which can control eg: Usage of raw material, Human Resources.

Uncontrollable Cost: Cost which cannot be control eg: Obsolescence of machinery, repairs of the machinery.

Original or Historical Cost: Cost of equipment at the time of purchase.

Replacement Cost: The Cost incurred for replacing the new machinery in the place of old machinery in the firm.

Abandonment Cost: Cost incurred for disposal of asset or machinery is called abandonment Cost.

Cost: Cost which would be incurred in the event of suspension of plant. eg: Storage of plant or machinery, construction of buildings, training the employees.

Urgent Cost: Must be incurred so that the production goes on. eg: Raw material cost fuel, power and wages for the labour.

Postpone able Cost: Cost whose postponement does not effect at least for some time on the firm and on production process and this coast can be paid after sometime. eg: Transportation charges, rent, interest.

Business Cost: Payment of the taxes.

Out of stock Cost: Loss of sale by shortage of goods in the market.

Fixed Cost: Cost which does not change when there is change in the production. It remains constant.

eg: Rent of the building, interest on capital, salaries, and wages.

Variable cost: Cost which changes in accordance with production change. Eg: Raw material, power, fuel.

Average Cost: Cost incurred for single unit of production in the total production.

Marginal Cost: Additional cost incurred by the firm by producing one more units extra.

Long run Cost: Cost incurred for the expansion of plant, for increase in the production of goods.

Short run Cost: Cost incurred for the production of extra units with the existing plant capacity without purchasing new machinery.

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