Cost allocation is a technique used to measure the profitability of your company’s product, service, department, or branch. It’s how you determine what each aspect of your business costs you. Cost allocation is an essential part of business financial management.

Why is Cost Allocation Important?

Total income and expenses tell you whether you’re making or losing money. Allocating costs highlights which areas of your company are profitable. Knowing the cost of specific parts of your business provides the information you need for financial decisions. 

It tells you if there are profit centers you should expand. It points out areas where you can improve productivity and profitability. It provides a basis for recognizing staff productivity in profitable sections.

What Expenses Do I Allocate?

Your expenses are unique to your business. However, the general categories are as follows:

• Direct costs apply to a specific product or service.
• Indirect costs are needed to provide your product or service but aren’t part of a specific product or service. 
• Materials that you can allocate to a specific product you sell.
• Manufacturing costs are needed but aren’t allocable to a specific product. 
• Overhead costs are necessary to operate your business but aren’t attributable to specific products or services. These are incurred independent of sales.
• Payroll, including payroll taxes. Payroll is part of all the other categories.

Some costs are fixed, and others are variable.

How Do I Allocate Costs?

Assign direct costs using per unit for products and per hour for services. Overhead and indirect costs are often accumulated in a cost pool. You then allocate them to each product or service. 

Often the allocations are based on total units or total hours. Some cost allocations might be determined by the square feet used. Other methods are machine hours, activities, or usage of utilities. Use what fits your business.

Allocating costs helps keep your business profitable. When you need additional funding, rely on Gipson Commercial Solutions. Our experienced experts will help you select financing that meets your needs. Contact us today for a complimentary analysis and free, no-obligation application.