How to do a cost analysis in six easy steps!

It’s very important for every business to perform a cost analysis. This is a procedure you will have to set up at different levels of business development including times when you want to invest more into your business.

You’ll also need to do a cost analysis if you want to open a new unit, expand your business or test a new market. Furthermore, if you want a loan from the bank, you’ll need a cost analysis. And if you’re looking for some angel investors, you guessed it right… A cost analysis is a must. So, how do you actually do one?

Six easy steps for creating a cost analysis

1. Determine the specific type of cost you’re evaluating;

2. Calculate your current operating costs (this is how much it costs you to run your business as it is);

3. Calculate your current profit;

4. Work out your new operating costs (this is how much it will cost you when you make changes to your business);

5. Calculate the new profit; and

6. Evaluate which option is more profitable.

As a useful tip, make sure all your calculations use the same time period e.g. per month or per year. Here’s an example that shows why a cost analysis is useful:

An example of how cost analysis can helped a business in decision making

James and Matthew’s company manufactures leather bags in Johannesburg, South Africa. They bought a bag manufacturing machine which they call ‘Jiggy’. They’ve also decided to look at buying a new bag manufacturing machine. A salesman offers them an option of two new machines to consider purchasing. Each new machine will increase the current number of bags they manufacture. The first new machine is the ‘Optimiser’ and it costs R1 110 000. The second new machine is the ‘Viber’ and it’s cheaper as it costs R908 000.

Matthew wants to buy the ‘Viber’ because it is cheaper. But, James wants to keep the ‘Jiggy’ because he doesn’t want to pay for a new machine. They have a decision to make to benefit their business. They need to do a cost analysis to see if they should replace the ‘Jiggy’ machine. The cost analysis will show which machine will benefit the business.

Caution: You can’t just make a purchasing decision based on price alone. It may be cheaper to purchase something upfront; but more expensive to run it in the long run. You need a cost analysis to account for all associated costs (support, maintenance etc.)