Blog on Service Costing
Service Costing
What is service costing
Service costing, or operating costing, is a process service organizations can use to determine all the costs associated with providing their services. Usually, it considers a variety of business factors, like:
Equipment costs
Labor costs
Fees
Software costs
Data storage costs
For some companies, there might be unique service costs to evaluate. By performing these calculations, organizations can determine the correct prices for their services and make other important financial decisions, like budgeting and controlling their fixed and variable costs.
What is service costing used for?
There are a few primary reasons companies use service costing, including:
Ensuring fair prices
One of the biggest reasons service organizations follow service costing processes is to establish prices for their intangible goods. They start by evaluating all the costs associated with the conception, production and delivery of their services. Then, they can determine fair costs for their customers while still meeting the company's financial needs.
Controlling costs
Most organizations use service costing to determine their overheads, or operational expenses. Companies often look at their fixed costs, which are operating costs that don't relate to the production or distribution of their services. Rent is an example of a fixed cost because it's a recurring charge that won't change based on a company's ability to sell their services.
Companies also consider certain variable costs, or costs that change based on the number of services a business delivers. Supply costs are an example of a variable cost because the prices of raw materials and equipment some service organizations use can fluctuate. By examining both these variables, along with other factors, organizations can better understand their financial position and create accurate budgets to control their costs and maximize returns.
Determining the cost per unit
Ultimately, the equation organizations use to perform their service costing processes helps them determine the cost per unit for their services. This measurement can differ based on the industry calculating the costs. For example, transport industries that transport goods might measure units as ton-miles. The boiler industry also uses service costing in their calculations, often using them to measure per cubic centimeter liters or per 1,000 pounds. The results of these calculations can offer valuable insights for service organizations and help them better understand their cost structures and needs.
Elements of service costing
When companies calculate service costs, they often look at several contributing factors. The exact factors they explore can depend on their industry type and specific costs. Here are some key elements that factor in to creating accurate service costing calculations:
Services: When determining operational and service costs, companies examine the services they offer to their customers to assess the specific operating costs associated with offering those services. The exclusivity or specialization of those services is another important factor to consider.
Financial data: Companies also review financial reports and documents in their calculations. Log sheets, bills payable and cost sheets are some examples of the documents financials professionals.
Working capital: Another factor in calculating service costs is assessing the company's working capital, or how much cash they have to pay for certain expenses. A low working capital could show that a business is struggling to generate the revenue it needs to pay its bills, but less working capital can often be a good thing for companies who've optimized their ability to cover operational expenses and invest their excess cash purposefully.
Industry specific unit costs: Different industries calculate their unit costs in unique ways. This element can differ from company to company.
Experts: Experts refer to the financial professionals who perform service costing calculations. Companies often determine whether they'd like to perform their assessments internally or outsource the work to service costing professionals.
Cost allocation: This service costing element affects how companies format their cost sheets and how they categorize their expensive. Fixed costs and variable costs are two categories of expenses companies often use.
Computation type: Some companies calculate their costs by order, whereas others evaluate periodic statements in their calculations. Specific calculation processes can depend on the industry, business and services provided.
Types of Service Costing
Different industries sometimes use alternate processes to make their calculations. This allows them to adjust for industry-specific expenses and factors. Here's a closer look at some popular types of service costing that shows how different industries might approach their evaluations:
Hotel costing: Hotels often have higher-than-average maintenance costs and also may account for depreciation in their service costing efforts.
Health care costing: Service costing can help hospitals and other health care providers determine fixed costs associated with their services, like labor charges. Other variable charges, like fees or medicine prices, are also important factors for health care organizations to consider in their costing calculations.
Transport costing: For transport companies, like trucking and delivery service providers, service costing can help them make important business decisions. Trucking companies, for example, might use service costing to understand how much it costs to transport select delivery items a specific distance so they can determine if certain service offerings make good business sense.
Energy provider costing: Energy providers' service costing efforts typically incorporate their methods for generating energy. Wind energy companies, for example, might consider specific costs like equipment depreciation and turbine services.
Food service costing: Keeping control over food costs can make it easier for food service businesses to find out important revenue information and optimize operational proficiency.
How to calculate service costs
How you calculate service costs can depend on your business, service provided and industry. While you may have to adjust some of these steps to suit your needs, here are some general steps you can follow:
1. Compile your fixed costs
To determine unit cost and perform service costing effectively, first collect data on your fixed costs. These are the costs that don't change and operate independently of the services you offer. Consider costs like insurance, rent or mortgage payments, taxes and interest.
2. Assess your variable and semi-variable costs
Next, determine your variable and semi-variable costs. Fluctuations in these numbers can affect your calculations, so you may have to update your figures to reflect current service costs if these numbers change. Variable costs can depend on the services you offer, meaning that changes in your services can affect changes in your variable costs. Some operating and maintenance costs might go in this category, along with supply costs.
3. Decide on a unit to measure
Service costing helps you determine unit costs for different business elements. For transport companies, cost per mile driven might be an effective data point. For hotels, cost per hour of cleaning service may be another. The unit you measure likely depends on your industry and service costing interests.
4. Determine your unit cost
With your fixed costs, variable costs and preferred unit to measure, you can determine your unit cost. If your unit costs contain two or more variables, a composite unit cost might be more beneficial. There may be many unit costs that factor into your calculations. For example, hotels might evaluate the unit cost of multiple services. If they have a restaurant, they could measure the unit cost of meals served and then have additional data to represent the unit cost for hours spent cleaning rooms.
To calculate unit cost, add all variable, semi-variable and fixed costs together, then divide by the number of units. Here's the formula:
Unit cost = total costs / number of units
For example, if a hotel wanted to determine the unit cost for cleaning hours, they could add labor costs, equipment costs and supply costs, then divide by the hours spent cleaning: ($60 + $2.16 + $3.12) / 4 = $16.32. Their unit cost, in the case that their unit is an hour, is $16.32.
Published by:
1. Siddhi Hulwane
2. Isha Venikar
3. Malhar Kapshe
4. Chaitanya Kulkarni
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