The cost management process involves identifying the activities that increase a company's costs and recording them for later use. Steps include the identification of cost drivers, calculation of overhead attributed to the production process, use of a general ledger to record costs, and cost analysis by management. The cost management process allows a company to determine how much each product costs to produce. The company can then compare its information to its competitors, and determine if the costs are higher than the current market level.
A cost driver is any direct or indirect activity that increases the incremental costs of a product. Two common cost drivers are the resources necessary to produce products: raw materials and labor. Companies can typically identify these drivers easily. Other drivers can include the cost to move materials around the company's facilities, quality management reviews by staff, equipment used to produce goods, and similar activities. Accountants will then use each of these cost drivers to allocate some portion of the activity's costs to the product.
The calculation of manufacturing overhead is the second step of the cost management process. Manufacturing overhead represents all indirect costs that may affect the production of a good. Indirect costs include maintenance on production equipment, utilities in the production department, security to protect the facility, and small materials necessary to produce goods but that are untraceable to individual products. Accountants will usually add all indirect costs identified during a specific stage of the production process. The costs are then allocated using an identified cost driver.
A general ledger is necessary to record all costs in the cost management process. Accounts include raw materials, labor, work in process, finished goods, and cost of goods sold. Large production companies will often have sub-accounts underneath each of these groups. Whenever the company incurs costs related to the production of goods, an accountant will record the items in the associated account. Using these accounts help accountants track costs easily and create budgets for management review.
As the management adage goes, "you can only expect what you inspect." The cost management process demands analysis to ensure a company is competitive in the business environment. Owners and executive managers will reviews the accounts in the general ledger and determine how efficient the company is when producing goods. For example, large quantities of raw materials without high production amounts can lead to increased holding costs for the inventory. This drives up the indirect costs of the company, leading to higher production costs.