Cost modeling involves the analysis of production costs, labor costs, material costs, and profit margins to determine the true cost of a product or service. It helps organizations understand the supplier’s pricing strategy and also be able to determine the actual price they should pay for a particular component or part. Cost modeling is a common activity in large organizations and has found wide acceptance all over the globe. Organizations are now driving business decisions based on insights derived from a large amount of data available through several credible sources. However, the small and medium manufacturing enterprises are still to catch on to this new trend in the market. This is largely due to the lack of technological infrastructure as well as the expertise to perform complex and challenging tasks like cost modeling by these organizations.
An organization cannot create a competitive advantage based on product innovation alone. To gain an edge and maintain a leadership position in the market, businesses have to focus on a robust supply chain management strategy. For this, the organization has to leverage cost modeling tools to identify the costs involved in procuring raw materials from various suppliers to receive top-quality materials at the best possible price. Cost modeling helps the organization to facilitate cost savings and drive profitability throughout the supply chain.
Why Should Small and Medium Manufacturing Businesses Use Cost Modelling Software?
For small and medium manufacturing businesses (SMBs), cost modeling helps improve their trend forecasting ability if coupled with predictive analytics. You ask how? Here’s how.
- Manufacturing and product development entail converting raw materials into a finished product. This means the organizations have to source and procure raw materials, process them to add value to them and distribute the final product.
- The costs for each activity involved in the source-to-customer process are not constant, instead, they vary from time to time. These SMBs need to forecast different SKUs, costs sales volumes, and revenues, and derive insights from the information available which is a difficult task as it requires additional knowledge and cost modeling skills.
- SMBs produce commodities known as intermediate goods that are used to produce finished products. The cost of these intermediate goods determines the cost of the final product. The typical customers for these intermediate goods are large organizations or original equipment manufacturers (OEMs) for instance an automotive company or a transportation company.
- For an SMB to survive in the market and make profits, it should be aware of its actual input costs and the effect it has on the finished product. Therefore, cost modeling enables SMBs to identify these costs, determine their impact on the final cost, and help SMBs establish accurate input costs. Hence, monitoring the process of such commodities, and identifying the factors that impact the total cost and eventually, the profit margins is vital for the company.
- A small and medium manufacturing business should integrate a cost-based approach and base its pricing strategy on the insights derived from an effective cost modeling tool.
At SpendEdge, we help organizations with real-time and accurate price tracking of input materials and commodities and provide supplier cost analysis to gain a detailed understanding of each component to enable procurement professionals to source the right products at the best price and thereby drive cost savings.
What are the different cost modeling tools
Activity-Based Costing (ABC):
Activity-Based Costing is a cost modeling tool that assigns costs to specific activities or processes within an organization. It involves identifying and analyzing the activities that consume resources and then allocating costs based on the drivers or factors that cause those activities. ABC provides a more accurate and detailed understanding of costs by considering the various activities involved in producing goods or delivering services. This tool helps organizations make informed decisions regarding pricing, product profitability, and process improvement.
Total Cost of Ownership(TCO):
Total Cost of Ownership is a cost modeling tool that evaluates the overall costs associated with owning and operating a particular asset or system over its entire lifecycle. TCO takes into account not only the initial purchase price but also factors such as maintenance, repairs, operating costs, and disposal costs. By considering the complete cost picture, TCO enables organizations to make more informed decisions when comparing different options or investments. It helps identify the most cost-effective solutions and can be particularly useful in procurement decisions or when evaluating long-term investments.
Cost-Volume-Profit (CVP) Analysis:
Cost-volume-profit analysis is a cost modeling tool that examines the relationship between costs, volume or quantity produced, and sales revenue. It helps organizations understand the impact of changes in volume or sales on their profitability. CVP analysis considers fixed costs, variable costs, selling price per unit, and the sales mix to determine the breakeven point, target profit levels, and the level of sales required to achieve those targets. This tool assists in decision-making related to pricing strategies, product mix, and sales volume planning.
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