Cost Estimation and Management Decision Areas in Business

Fixed Costs

Fixed costs are not a function of the output. They do not vary with the output. They cannot be avoided until the operation of the firm is closed. They are contractual (prime).

Recurring and Non-Recurring Costs

• Recurring: Predetermined expenses for running the business, e.g., salaries, repairs, maintenance.
• Non-Recurring: Not predetermined, regular budgeting, e.g., repair of a machine. Sometimes it is also planned.

Cost Estimation

Cost estimation is the process of finding an estimate, an approximation of a value, which will be used for some purpose, though it is completely uncertain and unstable. Estimation is typically a value from statistics used to estimate the value of a corresponding population parameter.

Learning Curve

The learning curve has to do with how people improve their performance of certain tasks. We determine the extent of training required and the ability to learn and adapt to new methods. With learning, new operators gather speed quickly, but with training, improvement will be there. Practice is plotted on the X-axis, and time per cycle is on the Y-axis. L = N(e^Q) - 1 / Q. It is directed to labor, rejects, and defects.

Advantages of Cost Estimation

1. Promotes the well-being and survival of the organization.
2. Embodies creative and innovative technology ideas.
3. Translates profitability to the bottom line through a valid and acceptable measure of rent.
4. Facilitates appropriate decisions to apply methods towards minimizing costs.

Average Cost, Marginal Cost, and Average Variable Cost

• Average Cost: Total Cost / Output
• Marginal Cost: d/dx (Cx)
• Average Variable Cost: Variable Cost / Output

Types of Cost Estimates

Per Unit Model

Here, a cost estimate is made for a single unit, then the total cost is estimated per unit times the number of units. This model is applicable for those types of products where labor, material, and other costs are indefinable and determined for a single product.

Segmentation Model

Here, the partition of the total estimate is divided into segments. Then, segments are combined for the total estimate. For example, if the cost of a student festival is calculated, it is divided into many sections. The cost of each segment is calculated and derived to make a single segment.

Power Sizing Model

This model states that the cost of production of a product will increase in different proportions as a unit is increased. This is an effect of economies of scale. Here, we use scale-up and scale-down for known costs. It uses an exponent (X), called the power sizing exponent, to reflect the economy of scale in size or capacity.

Areas of Management Decision

Operations Management, Quality, Materials, Finance, Human Resources, Marketing, Project Management.

Life Cycle Cost

Life cycle cost involves a mixture of managerial, engineering, and financial practices applied to physical assets to achieve the economic life cycle cost. It is the efficient way of utilizing it so that it costs the lowest during the lifespan of the asset. Therefore, it attains a trade-off between higher capital cost and lower running cost. We use Just-In-Time (JIT) philosophy to bring the exact amount of spares and eliminate the cost of keeping them in inventory for a long time. It also reduces the cost during the manufacturing process.

Sunk Cost

This is a cost that has already been incurred in the past and is not relevant to the decision-making process. For example, any survey or market research to determine whether the job should be taken or undertaken is a sunk cost. Here, it is relevant to the decision. It cannot be recovered.