What Is an Underlying Cost?

"Underlying cost" is a term that is used to identify any recurring expenses that a business will have to settle during the next financial period, such as the upcoming calendar month. Costs of this type are normally connected with the ongoing function of the business operation and are focused on costs that are considered standard and usual. Expenses that arise unexpectedly are considered to be different from any type of underlying expenses.

An underlying cost is a predictable expense that will be incurred and must be paid during the upcoming accounting period. Some of the more common examples of these types of costs include the utilities consumed in order to operate any locations connected with the business. In the event that the company rents or leases office or warehouse space, that rental payment that is due during the upcoming budget period is classed as an underlying cost. The mortgage payment that will be due during the next calendar month will also be classed as this type of expense.

Identifying each underlying cost associated with the business operation is key to creating and following a viable budget plan. By allocating funds to manage each of these basic expenses, the company is able to remain in full operation for the period under consideration. Failure to do so can have severe ramifications. For example, if the company fails to pay the underlying cost known as the monthly power bill, there is a chance the service will be shut down, an event that would seriously impact the productivity of the business.

In addition to identifying each underlying cost, it is also important to make sure that the budget reflects an accurate amount of funds set aside for each of those expenses. This is often accomplished using several different methods, such as allocating funds based on the average monthly cost over the most recently completed calendar year, using the highest actual monthly cost as the benchmark for the allocation, or making projections based on the per unit cost and the anticipated number of units that will be consumed during each monthly period.

Not every expense that must be settled in the next accounting period fall can be properly classed as an underlying cost. This is particularly true of an unexpected expense that originates due to some crisis or catastrophe experienced by the operation. For example, if severe weather results in a shutdown of a manufacturing plant for several days, this will result in an increase in the average cost per unit produced for the month. That difference in cost will not be treated as an underlying cost, since that increase is only temporary. In general, any type of expense that can be considered a one-time event will not be considered an underlying cost.