Question

Discuss why financial managers in organizations need to know the full cost of producing goods and/or providing services.

Answer 1

Financial manager are responsible for the financial health of organization .They will develop strategies and plan for long term financial goal of the organization. Their basic functions are as follow:

• Determine capital structure of the organization.
• Estimate the amount of capital required in business.
• Management of cash.
• Procurement of funds.

For accomplishing their basic functions financial manager needs to know the full cost of producing goods or providing services so that he will take appropriate pricing decision, evaluate companies performance, generate financial reports and last but not the least sell or process further

1. Appropriate pricing decision:

   Knowing how much your organization spends to produce goods or providing services is indispensable when figuring out the sales price. If you plan on competing on price, you will want to ensure that your product is priced lower than that of your competitors, but if you sell your product for less than its cost, you won't be in business for very long. Therefore costing is useful for setting a normal sales price, also useful for determining whether or not to take special orders at lower prices. In many cases, fixed costs of production, such as rent and management salaries, are already covered by normal production. Companies in that situation can accept a lower price than normal in order to win a special order. Costing techniques allow you to determine how long you can go and still come out with a profit.

2. Company Performance

   As costing methods have uniform rules, managers have to rely on the consistency of costing techniques to evaluate performance across companies. For example, if you are the manager of a soft drink business, you can look at a publicly-traded competitor for a rough ballpark estimate of how that company is doing. By examining the company's filings, you can determine how many units of product the company sold and at what cost. You can then determine the cost per unit, and compare this to your company's cost per unit. While a larger company could be expected to have a lower cost per unit than a smaller company, figuring out if the two companies are in the same ballpark can be worthwhile.

3. Financial Reporting

   Costing techniques are required under generally accepted accounting principles, called GAAP, for external financial reporting purposes. GAAP requires that all manufacturing costs are assigned to product, and that no non-manufacturing costs are assigned to products. Costing systems that treat costs in this manner are known as absorption, traditional, or full-cost costing systems. Small-business owners should recognize that not all costing systems treat costs in this manner. For example, variable costing systems seek to stabilize net income with regard to changes in production levels, so they do not assign all manufacturing costs to products. This method of costing may be useful for internal decision making, but would not be appropriate for external reporting.

4. Sell or Process Further

   Costing methods are important when companies are deciding whether to sell an intermediate product or to process the product further. For example, a dairy has many options to consider when determining what products to bring to market. The dairy could sell raw milk to a creamery, process the milk into pasteurized dairy products, make butter or ice cream, or produce cheese. By using a costing technique called relevant cost analysis, the dairy's owner can determine what amount of processing is the most profitable for the dairy.