Costing improves profitability and is therefore of paramount importance for any business, including service companies. This is particularly true in these times of uncertainty.
Like manufacturing companies, service companies are constantly evolving and will need to arm themselves better than ever to stay the course and consolidate their operations in order to face the uncertainties of the coming months. Managers must have all the information they need to make informed decisions and ensure the company’s financial performance.
By definition, costing is the sum of all expenses needed for producing a good and finalizing a service.
Establishing costs for informed decisions
There are several advantages to knowing and controlling the cost of your services, such as:
• Determining the sales price of services;
• Making informed decisions about contracts (because in negotiations with the client, the manager is better able to understand the available margins);
• Recognizing the difference between profitable and non-profitable services.
In many companies, costing is a neglected management tool, either because of lack of time or lack of knowledge.
As a result, many managers navigate rough waters and cannot rely on costing in the many strategic decisions they must make.
Here are some points indicating that you would need to update or review your costs:
- You have had to review your priorities because of the pandemic;
- Your costs were last updated more than a year ago;
- Significant changes were made within your business;
- Your range of services has increased and you don’t know how to price your new services;
- You’re not sure you included all of the relevant costs in your costing;
- Your profit margin does not reflect the estimated profit margin at the time of a tender.
To evaluate the cost of a service, you have to understand that it is composed of several elements:
- Operating costs;
- Sales expenses;
- Administration expenses.
When determining your costs, one of the most common pitfalls is to evaluate a resource’s hourly rate based on hours worked rather than taking into account productive hours (vacation and other days off, breaks and training).
For example, if we take an employee with a $25 hourly rate including benefits, this is equivalent to an annual salary with benefits of $52,000 per year. This annual expense, based on the number of productive hours per year ($52,000/1,660 hours in our example), gives us a productive hourly rate of $31.33. It is this rate that should be taken into account when assessing a service contract and not the $25 hourly rate.
When assessing your services, you will be confronted with several traps . One of the most important ones to avoid is postponing the project or waiting for 100% accurate information to determine the cost price. Remember that, like your company, costing is a constantly evolving process.