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Cost Structure in Business Model Canvas: The Cornerstone for Building a Profitable Business Model

Published: 19 July, 2023

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Table of Contents

Businesses often struggle with managing their finances. With a great idea and a great product or service, it’s easy to just assume all the bills will get paid and everything will turn out all right. People who start businesses are energized by the value they’re delivering but are measurably less enthusiastic when it comes to actually running the business.

Understanding how a business’s Cost Structure influences the entirety of the operation is essential for ensuring the company’s success. Seeing it at work within a larger Business Model Canvas helps put your Cost Structure into the proper context.

In this article, we discuss the role of Cost Structure in your overall business model, and how adjusting it is an important site of innovation loaded with possibilities. We touch on some of the reasons why Cost Structure plays such a vital role in business innovation. We also discuss some ways to alter your Cost Structure to make innovation and transformation possible. The experts at Digital Leadership have plenty more to say about all of this, so don’t hesitate to reach out through our website.

Cost structure definition

Cost Structure refers to all the ways a business approaches paying its bills, such costs take many forms: the fixed cost of building rental, the variable cost of hourly wages, the sometimes-unpredictable costs of repairs or disaster response.

How a business prepares for fixed and variable costs, overhead expenses, production supplies, and any number of other concerns must be completely reflected in its cost structure.

Cost Structure is the aggregate of all the ways a business must spend money. Companies can use Cost Structure within an overall Business Model to identify where expenses can be reduced.

Cost Structure in Business Model Canvas

Cost structures play a key role in the Cost Model of your Business Model Canvas. The cost structure concept helps guide how you target innovation and value proposition development. Through understanding cost structures, you can aim to reduce costs, as well as make the most from every cost your business incurs.

Business Model Canvas Building Blocks

Cost Structure is just one of the many building blocks of the Business Model Canvas. It’s useful in understanding the overall impact of Cost Structure to consider the remaining fields in the Canvas.

We’ve written about the Business Model Canvas Building Blocks before, so they are presented here only briefly. Unlock the full potential of your business and gain a deeper understanding of your cost structure with The UNITE Business Model Canvas. This powerful and innovative framework offers a comprehensive approach to visualizing and analyzing your cost-related aspects within the context of your entire business model. By using the UNITE Canvas, you can identify cost drivers, allocate resources efficiently, and uncover opportunities for cost optimization. You can download it now!

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You can now access the complete Business Model Canvas Package, including a full presentation, related models and instructions for use.

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Related Article: Business Model Canvas 101: Everything You Need to Know to Succeed

(1) Key Resources

A list of your Key Resources, which can be categorized into physical, financial, intellectual property, and unique people skill sets. Their placement in the Business Model Canvas ensures that we give them full consideration from multiple angles.

(2) Key Activities

Your Key Activities should never be outsourced: they’re far too important. But other, tangential activities that are necessary though not at the core of your business (copy machine maintenance, for example) can be handled by contractors or other outside entities.

(3) Key Partners

Without your Key Partners , your Core Activities would be impossible. Relationships with your Key Partners, therefore, are vital to your success and should be nurtured and cared for appropriately.

(4) Distribution Channels

Rarely does a company deliver its goods or services to customers without some third-party distribution channels . Understanding the role Distribution Channels play in how we deliver value to our customers is important to understanding the overall Business Model.

(5) Customer Relationships

Different businesses have different relationships with their customers, but they should never be positioned in opposition to each other. The clearest way of ensuring proper attention is paid to Customer Relationships is through the Jobs to be Done framework , which is a major segment of the UNITE eXtended Business Model Canvas.

(6) Customer Segments

Personas help you understand who your customers are as people within their broad segments so you can better reach them and bring them value. Through them, you differentiate between different customer segments.

(7) Revenue Streams

Revenue Streams outline how you earn money. A Business Model can involve transactional revenues resulting from one-time customer payments (e.g., a sale) or recurring payments (e.g., a subscription).

(8) Value Proposition

It helps to project, test and build the business Value Proposition in a more structured and reflective way, just as the Business Model Canvas helps you do so during the process of designing a Business Model. Including the Value Proposition Canvas as an element of the more extensive Business Model Canvas helps give you full visibility into your plans. It’s more than worth the added effort.

Cost Structure Examples

The Cost Structure is a key component of the Business Model Canvas (BMC), a strategic management tool used to describe and analyze a business model. It outlines the major costs and expenses associated with operating a business. Here are some examples of cost structures that businesses may encounter:

• Rent or Lease Payments: The cost of renting office space or a manufacturing facility.
• Salaries and Benefits: Regular salaries paid to employees and associated benefits such as insurance and retirement contributions.
• Insurance: Business liability insurance, property insurance, etc.
• Depreciation: The allocation of the cost of assets over their useful life.
• Utilities: Regular expenses for electricity, water, gas, internet, etc.
• Raw Materials: Costs associated with purchasing materials to produce goods.
• Manufacturing Costs: Expenses related to the production process, such as direct labour costs.
• Sales Commissions: Payments made to sales representatives based on the volume of sales.
• Shipping and Freight: Costs for delivering products to customers.
• Cost of Goods Sold (COGS): The direct costs of producing goods or services sold by a company.
• Marketing and Advertising: Promotional costs to attract customers and increase brand visibility.
• Research and Development (R&D): Expenses related to developing new products or improving existing ones.
• IT Infrastructure: Costs associated with maintaining computer systems and software.
• Customer Support: Resources allocated to assist customers with inquiries or issues.
• Office Supplies: Expenses for basic supplies necessary for office operations.
• Marketing Campaigns: Costs associated with advertising and promotional activities to attract new customers.
• Sales Team Expenses: Salaries, commissions, and other costs related to the sales team’s efforts to acquire customers.
• Free Trials or Discounts: Costs incurred from offering free trials or discounts to entice new customers.
• Warehousing: Expenses related to storing and managing inventory.
• Distribution Channels: Costs associated with utilizing third-party distributors or sales channels.
• Warranty and Repairs: Costs related to honouring warranties and repairing or replacing defective products.
• Customer Service: Expenses for assisting customers with post-sale inquiries or issues.

Differentiating Cost Structure Types for Your Business

There’s a good chance you don’t know, at least not in a formal way. To be successful, Cost Structures need to be intentional. Unless you’ve made a selection and followed through, you’re probably experiencing unnecessary costs.

What are the different Cost Structures that might appear in your Business Model Canvas? Let’s look at some.

(1) Fixed Cost Structure

The most predictable kinds of costs are Fixed Costs, and a Fixed Cost structure is useful for many types of businesses.

Definition & Explanation

These are costs incurred no matter how many goods or services the business produces. These costs tend to be recurring, like rent, insurance, or loan payments. A fixed cost is usually predictable.

Fixed costs are often capital investments and other overhead costs.

Advantages and Disadvantages

Many of the advantages and disadvantages of a Fixed Cost Structure centre around the consistency and the constancy associated with this approach.

Some advantages of fixed costs in a business plan are:

• Budgeting predictability: Fixed costs provide a level of predictability in budgeting and financial planning, as they remain constant regardless of changes in sales or production levels.
• Planning stability: Fixed costs provide stability to a business plan and make it easier to plan for the future.
• Cost control: Fixed costs allow businesses to control costs better by ensuring that a set level of expenses is incurred each period, regardless of fluctuations in sales or production.
• Price setting: Fixed costs provide a basis for setting prices, as they are a known and constant expense that must be covered by sales.
• Investment justification: Fixed costs can be used to justify investment in long-term assets, as they provide a predictable ongoing expense for the life of the asset.

Some disadvantages of fixed costs in a business plan are:

• Inflexibility: Fixed costs are set and cannot be easily adjusted, making it difficult to respond to changes in market conditions or demand.
• Predictability: Fixed costs can be difficult to predict, making it challenging for businesses to accurately forecast their expenses.
• High burden: Fixed costs can place a high financial burden on a business, especially if sales are slow or there is a downturn in the market.
• Limited resources: Fixed costs can tie up a significant portion of a company’s resources, leaving less available for investment in growth opportunities.
• Cash flow challenges: Fixed costs can strain a company’s cash flow, making it difficult to meet regular expenses or make investments in the business.

(2) Variable Cost Structure

Not all costs are as predictable as Fixed Costs. When costs are subject to (sometimes large or quick) changes, these are Variable Costs, and like a Fixed Cost Structure, a Variable Cost Structure has its uses and challenges.

A variable cost changes in relation to how many goods or services the business provides. While these costs can be predictable if the business is planning properly, they are not the same from one period to the next.

Variable costs include direct labour costs, direct materials costs, and maintenance payments.

Advantages of variable costs in a business plan’s cost structure include:

• Flexibility: Variable costs can change as production levels change, allowing businesses to adjust their costs to meet fluctuations in demand.
• Predictability: Variable costs are often directly tied to a specific unit of output, making it easier to predict the cost of production.
• Improved profitability: Since variable costs change as production levels change, businesses can increase their profitability by reducing their costs as production slows down or by increasing production to take advantage of favourable market conditions.
• Better cost control: By focusing on controlling variable costs, businesses can improve their overall cost structure and achieve better margins.
• Increased focus on efficiency: Because variable costs are directly tied to production, businesses are encouraged to focus on improving their processes and becoming more efficient to reduce their costs.

Disadvantages of variable costs in a business plan’s cost structure include:

• Volatility: Variable costs can be subject to fluctuations, which can make it difficult for businesses to plan and budget accurately.
• Lack of control: Variable costs are often outside of a business’s control, such as raw materials prices, which can lead to unexpected cost increases.
• Difficulty in planning: Because variable costs can change frequently, it can be challenging to accurately forecast expenses and plan for future production.
• Increased risk: Businesses with a high proportion of variable costs may be at a higher risk of financial instability, as their costs can change quickly and unpredictably.
• Reduced stability: Since variable costs change with production levels, businesses with a high proportion of variable costs may experience significant financial swings, which can reduce stability and make it difficult to maintain a consistent cash flow.

(3) Hybrid Cost Structure

Some businesses are in a position that lets them have a blend of Fixed and Variable costs.

In reality, most businesses have both types of costs in one way or another. But in a Hybrid Cost Structure, businesses are making an explicit choice to be sure to utilize both Fixed and Variable costs.

A Hybrid Cost Structure refers to a business model that combines elements of both fixed and variable cost structures. In this model, some costs are fixed and do not change with changes in output or sales volume, while others are variable and increase or decrease with changes in output or sales volume.

With a Hybrid Cost Structure, businesses try to balance the benefits of stability and predictability offered by fixed costs with the flexibility and responsiveness offered by variable costs.

The advantages of a hybrid cost structure in a business plan cost structure include the:

• Improved predictability: By combining both fixed and variable costs, a hybrid cost structure allows businesses to have a more accurate understanding of their costs, which can improve their ability to forecast expenses and plan for future production.
• Better cost control: A hybrid cost structure gives businesses greater flexibility to control their costs, as they can adjust their variable costs based on changes in production levels while maintaining a stable base of fixed costs.
• Increased stability: By having a mix of fixed and variable costs, businesses can reduce the volatility in their cost structure and achieve a more stable financial position.
• Improved cash flow management: A hybrid cost structure allows businesses to better manage their cash flow, as they have a predictable base of fixed costs, which can help with budgeting and planning.
• Increased flexibility: A hybrid cost structure allows businesses to adjust their cost structure in response to changes in the market or changes in their production levels, which can increase their ability to respond to new opportunities or challenges.

Disadvantages of a hybrid cost structure in a business plan’s cost structure include:

• Complexity: A hybrid cost structure can be more complex to understand and manage than a purely fixed or variable cost structure, which can make it more difficult for businesses to plan and budget accurately.
• Increased difficulty in forecasting: Because a hybrid cost structure involves both fixed and variable costs, it can be challenging to accurately forecast expenses and plan for future production.
• Reduced focus on efficiency: A hybrid cost structure may result in businesses having a reduced focus on efficiency, as they have a mix of fixed and variable costs, which can lead to complacency in cost management.
• Increased overhead costs: A hybrid cost structure can result in increased overhead costs, as businesses may need to invest in additional resources to manage the complexity of their cost structure.
• Less straightforward cost structure: A hybrid cost structure may not be as straightforward as a fixed or variable cost structure, which can make it more difficult for stakeholders to understand the financial position of the business.

Factors to Consider When Choosing a Cost Structure

Like everything else in your enterprise, your Cost Structure will depend upon a combination of factors unique to your business. Let’s unpack some of the factors you should keep in mind when deciding upon your business’s Cost Structure.

(1) Business size and stage of development

Larger businesses typically have a more complex cost structure, with a larger proportion of fixed costs and a greater number of employees and operational expenses. On the other hand, smaller businesses tend to have a simpler cost structure, with a greater proportion of variable costs and lower overhead expenses.

Additionally, as your business grows and becomes more established, you may see a shift towards a higher proportion of fixed costs as you invest and expand.

Understanding how your business and its interests will change over time will help you recognize the need to change your Cost Structure.

(2) Industry type and competition

Different industries have different cost considerations based on factors such as the price of raw materials, the level of regulation, and the type of products or services offered. For example, a manufacturing company may have a higher proportion of variable costs to take into account the change in price of raw materials, while a service-based company may have a higher proportion of fixed costs as it projects employee compensation.

Competition can impact a company’s cost structure as businesses compete to offer the lowest prices or the highest quality products and services. You may need to make adjustments to how you do business based on others in your sector or changing beliefs in the marketplace.

(3) Product or service offered

If you are a business offering a product, then your cost structure will be influenced by the labour and raw materials that go into manufacturing. You may also experience shifts in costs to deliver your goods to consumers, a reality that was felt particularly acutely during the height of the global COVID-19 pandemic. Businesses that plan for shifts in these costs are much more robust than their competition.

If you are offering a service, while you may have some costs for materials, your main cost will be employee compensation. These are generally predictable, allowing you to plan for a somewhat stable future.

(4) Market demand and customer behaviour

Finally, the demand for your product or service will influence your costs. You’ll need to find the balance between economy of scale and not over-stocking supplies.

A business can use variable pricing strategies to align its costs with changes in customer demand. For example, a business may offer discounts or promotions to encourage higher sales during slow periods or increase prices during periods of high demand to maximize its revenue potential. You can plan for these, taking advantage of current trends and the availability of resources.

Cost Structure is an important component of your Business Model, so understandably, it features in the Business Model Canvas as well as other useful planning tools.

When considered properly, your Cost Structure is another aspect of your business ripe for innovation and development.

Frequently Asked Questions

1- can a business change its cost structure over time.

Of course, a business can change its Cost Structure over time. As the business matures, or as the marketplace changes, Cost Structure should always be considered as an opportunity for innovation to leverage competitive advantages.

2- What are the 8 types of cost?

• Direct Costs: Expenses directly linked to producing a specific product or service.
• Indirect Costs: Overhead expenses supporting overall business operations.
• Fixed Costs: Constant expenses, unaffected by changes in production or sales.
• Variable Costs: Fluctuate based on changes in production or sales volume.
• Operating Costs: Day-to-day expenses necessary for running the business.
• Opportunity Costs: Potential benefits lost when choosing one alternative over another.
• Sunk Costs: Expenses already incurred and irrecoverable.
• Controllable Costs: Expenses that can be managed or influenced by specific individuals or departments.

3- What are some common mistakes businesses make when it comes to Cost Structure?

The first mistake many businesses make in regard to Cost Structure is not thinking about it at all. Cost Structure is an integral piece of your overall Business Model, which is why it’s included in tools like the Business Model Canvas.

The next common mistake businesses make is that they are often too entrenched in the status quo. Evaluating your Cost Structure should be a piece of your overall innovation plan.

4- Can a business have multiple Cost Structure types for different products or services?

Yes, some Cost Structures are more appropriate than others for different Business Models.

5- What are cost structures in marketing?

In marketing, the cost structure refers to the breakdown of expenses incurred in the process of promoting and selling products or services. Understanding the cost structure in marketing is essential for businesses to allocate resources efficiently and make informed decisions regarding their marketing strategies. Here are some key elements of the cost structure in marketing:

• Advertising and Promotion: Expenses for online and offline advertising, and promotional materials.
• Marketing Personnel: Salaries, bonuses, and training for marketing and sales teams.
• Market Research and Analysis: Costs for gathering consumer insights and market research.
• Digital Marketing Tools: Expenses for using digital marketing platforms and software.
• Content Creation: Costs for producing marketing content like blogs, videos, and infographics.
• Events and Trade Shows: Budget for participating in trade shows and events.
• Distribution and Sales: Expenses related to product distribution and sales efforts.
• Public Relations: Costs for PR agencies or in-house PR activities.
• Influencer Marketing: Expenses for collaborating with influencers.
• Social Responsibility: Costs for cause-related marketing efforts.
• Testing and Experimentation: Budget for trying new marketing strategies.
• Affiliate Marketing: Costs associated with affiliate commission payments.

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Material Cost: A Guide to Understanding

Understanding how to calculate and manage material cost is crucial for success whether you’re an experienced business owner or just starting out.

In this guide, we’ll explain and review factors that influence material costs, such as supply and demand, market trends, and production processes.

What is Material Cost?

Material cost is defined as costs associated with required materials to manufacture a product or provide a service. Understanding these costs is important for businesses of all sizes. Whether manufacturing products or providing services, material costs can significantly impact the bottom line.

A key benefit in understanding material costs is the ability to estimate the cost of production accurately. This ensures you set competitive prices for your products or services without overcharging customers or leaving money on the table.

In addition, by tracking material costs, you can ensure that you have adequate stock on hand to meet customer demand without tying up excessive inventory capital. This can help improve cash flows while reducing the risk of stockouts or overstock situations.

Factors Affecting Material Cost

Several factors influence costs. Understanding these factors is essential for accurate cost estimation and management.

Supply & Demand

The basic principles of supply and demand have a tremendous effect on pricing. When demand exceeds supply for a certain material type, prices often rise. Conversely, when supply exceeds demand, prices often fall. Understanding these dynamics within an industry can help one anticipate and react to such changes proactively.

Market Trends

Market trends, like changes in consumer preferences or technological advances, may also impact material costs. For example, prices may increase if a surge in demand for a certain material type occurs due to a new trend. Remaining informed regarding market trends can help you stay ahead of competing businesses.

Production Processes

The production cycle involves transforming raw materials into finished products. A complex production process can require additional materials or special equipment, driving up costs. Furthermore, the production process can help you identify cost-saving opportunities or lead to alternative manufacturing methods.

Types of Material Cost

It’s important to understand cost types. Businesses typically encounter two primary types.

Direct Material Cost

This involves products used to produce goods or services. Examples include raw materials like wood, silver, aluminum, components, or other items necessary to produce a final product. Additionally, this is the largest cost type and should be monitored closely to ensure accurate estimation.

Indirect Material Cost

This involves products not directly used in the production process but are required for day-to-day operations. Examples may include maintenance materials like cotton pads to clean machines, oil, glue, or any other materials that support the production process. These costs also need to be accounted for to ensure accurate cost estimation.

Material Cost Calculation

Accurately calculating direct and indirect costs is essential for businesses looking to optimize profitability. Although calculation methods vary depending on the industry, one can follow the below general steps to calculate and assign unit of production costs.

1. Identify Materials

The first step is identifying all materials required for the production process. This includes both direct and indirect materials. Make a comprehensive list of all needed items.

2. Determine Quantity

After required items have been identified, factor the quantity of material required for the production process. This may be done by reviewing past production records, consulting with suppliers, or analyzing time and motion studies. [1] Harvard Business Review. " Time & Motion Regained ."

3. Determine Unit Cost

After determining the quantity, define the unit cost of each material. This can be obtained by contacting suppliers, conducting market research, or analyzing historical purchasing data. Considering factors such as bulk discounts, shipping costs, and other additional expenses associated with acquiring the materials is essential.

4. Calculate Total Material Cost

Multiply the quantity of each material by its unit cost to calculate the total cost. Sum up the total to obtain the overall cost for a specific production run or project.

1,000 pieces of fabric (quantity) x  $2 (unit cost) = $2,000 (total cost)

5 gallons of glue (quantity)  x  $8 (unit cost) = $40 (total cost)

$2,000 (total cost)  +  $40 (total cost) = $2,040 (total material cost)

5. Consider Other Factors

In addition to the direct costs of materials, consider other factors that may impact overall costs, such as waste, scrap, or spoilage. These factors should also be included.

Reducing Material Cost

Cost reduction is often a priority for companies seeking profitability improvements. Let’s explore reduction strategies often used without compromising quality or customer satisfaction.

Supplier Negotiations

Companies can secure better pricing, bulk discounts, and other saving strategies by building strong relationships with suppliers in order to negotiate favorable terms. Regularly reviewing existing supplier contracts and exploring alternatives can help businesses identify cost-saving opportunities.

Value Engineering

Value engineering is a systematic approach to reducing costs while maintaining or improving product quality without compromising performance or functionality. It involves re-evaluating the design, materials, and production methods to identify saving opportunities. [2] Investopedia. " Value Engineering ."

Lean Manufacturing

Lean manufacturing principles focus on eliminating waste and optimizing production processes. By utilizing techniques such as just-in-time inventory management, reducing setup times, and improving production efficiency, businesses can minimize waste. [3] American Society of Mechanical Engineers. " 5 Lean Principles ."

Material Substitution

Exploring alternative products may help reduce expenditures. By researching and evaluating different materials, businesses can identify options that offer similar performance but at a lower cost. It’s important to consider factors such as quality, availability, and compatibility with existing production processes.

Waste Reduction

Minimizing waste or nonconformance costs is also a key reduction strategy. Waste minimization techniques like recycling, reusing scrap materials, or optimizing material handling processes may allow businesses to reduce the amount of waste, thereby reducing costs.

Material Cost Challenges

Managing material expenditures can present several challenges for businesses. Let’s explore common challenges and common ways to address them.

Fluctuating Material Prices

Market dynamics, supply and demand, along with other factors may cause varying material prices over time. Remaining informed of market trends, establishing strong supplier relationships, and implementing purchasing strategies such as forward contracts or hedging can help address this challenge. [4] CFA Institute. " Pricing & Valuation of Forward Commitments ."

Supplier Reliability

Late deliveries, quality issues, or sudden disruptions in the supply chain can lead to higher pricing and production delays. Therefore, companies should carefully evaluate suppliers, have backup suppliers, and ensure lines of communication remain open to address issues proactively.

Inaccurate Cost Estimation

Estimation requires careful analysis and consideration of various factors. To address this challenge, businesses should invest in cost estimation tools, regularly review and update estimation methods, and ensure effective communication between the purchasing and production departments.

Lack of Visibility

Lack of inventory visibility can make it challenging to manage costs effectively. Therefore, businesses should implement robust inventory management systems, leverage technology solutions like enterprise resource planning (ERP) software, and establish clear communication channels between departments involved in material management. [5] Oracle. " What is ERP ?"

Tools: Managing Material Cost

Effective management requires the right tools and resources. Fortunately, there are several options to help oversee this process.

Cost Estimation Software

Estimation software can help businesses accurately project material costs by automating the calculation process while considering factors such as additional expenses. These solutions often provide advanced features like historical cost tracking, supplier performance analysis, and scenario modeling.

Inventory Management Systems

Robust inventory management systems are crucial. They help businesses track inventory levels, monitor usage, and optimize reorder points. By leveraging these systems, companies can reduce stockouts and minimize excess inventory.

Relationship Management Tools

Supplier relationship management tools help businesses effectively manage their relationships. These tools often provide features such as supplier scorecards, contract management, and communication portals, allowing businesses to optimize their relationships and drive cost savings.

Market Research & Analysis

Staying informed about market trends and industry dynamics is essential for managing material costs. Businesses can leverage market research reports, industry publications, and online resources to gain insights into market trends, pricing dynamics, and potential savings opportunities.

Professional Networks

Joining professional networks and associations can provide businesses access to valuable insights, best practices, and industry-specific resources. Furthermore, these networks often offer educational events, networking opportunities, and forums for knowledge sharing, helping businesses stay up-to-date with the latest strategies.

Cost Reduction Examples

Examples can provide valuable insights into successful material cost management strategies. Let’s explore a few scenarios.

Example 1: Auto Manufacturer

An automotive manufacturer implemented lean manufacturing principles to optimize their material cost management processes. By eliminating waste, reducing setup times, and improving production efficiency, the company achieved a 15% reduction in expenditures while maintaining product quality.

Example 2: Construction Company

A construction company identified an opportunity for cost savings by substituting traditional building materials with more cost-effective alternatives. The company was able to reduce their expenditures by 20% without compromising the quality or durability of the structures.

Example 3: Retailer

A retailer implemented analytics tools to analyze sales data, inventory levels, and supplier performance. By leveraging data-driven insights, the company optimized purchasing decisions, negotiated better terms with suppliers, and reduced material costs by 10%.

Understanding material costs is essential for businesses looking to optimize profitability, make informed decisions, and gain a competitive edge.

Companies can achieve significant cost reductions and improve their bottom line by understanding factors influencing material costs, accurately calculating material costs, and implementing effective cost-saving strategies.

Additional Resources

Other helpful articles may include:

Merchandise Purchases Budget Understanding Budgeted Cost Cost Based Pricing Explained What is Step Variable Cost?

Published by John Henry, MBA

Manufacturing Costs: Significance, Types, and Cost Calculation

Table of Contents

Wondering how manufacturing companies determine their costs and ensure they stay profitable?

Whether you’re just starting your own manufacturing business or are looking to venture into the field of cost accounting , understanding manufacturing costs and knowing how to accurately calculate them is crucial for success. 

In this comprehensive guide, we will explain what manufacturing costs are and delve into: 

• The different types of manufacturing costs,
• The step-by-step process of calculating them,
• Examples of manufacturing costs, and
• The benefits of calculating manufacturing costs.

Let’s get started.

What are manufacturing costs?

Manufacturing costs, also called product costs, are the expenses a company incurs in the process of manufacturing products.

Manufacturing costs include:

• Direct costs and 
• Indirect costs . 

Accurate cost calculation helps companies identify the processes or materials that are driving up manufacturing costs and determine the right pricing of products — the keys to remaining profitable.

That’s not all.

According to McKinsey’s research , cutting down manufacturing costs, in addition to boosting productivity , is the key for manufacturing companies to remain competitive.

Now, let’s explore both types of costs in more detail.

What are direct manufacturing costs?

Direct manufacturing costs are expenses that can be attributed directly to the production of a specific product. They include costs related to: 

• Direct materials: these are the tangible inputs (or raw materials) used in the manufacturing process. For instance, the cost of the screen and electronic components would be considered direct material costs if these materials are readily traceable to the finished product (for example, glass used to make light bulbs). 
• Direct labor: this involves the wages and benefits paid to workers who are directly involved in assembling or creating the product, such as welders, assemblers, and machine operators. For example, the wages of assembly line workers working on the smartphone production line fall under direct labor costs. In addition to basic wages, direct labor costs will also include overtime pay, payroll taxes, and benefits (health insurance, workers’ compensation, retirement plans, and contributions to social security or pension funds).
• Expenses directly linked to the manufacturing process or the manufactured product: costs associated with the use of utilities like electricity, water, and natural gas that are directly tied to the production process also qualify as direct costs. 

What other costs should you include when computing the cost of direct materials? 

According to Zaher Dehni , EA-certified tax professional at Taxfully, you will also need to consider:

• The procurement price of raw materials (the cost involved in finding suppliers, storing raw materials, and so on),
• The cost of shipping the raw materials to the production site, and 
• Any pertinent duties (a form of tax) associated with importing raw materials.

When you add up all these direct costs, you get the Cost Of Goods Sold (COGS), a term used in accounting when preparing the company’s financial statement.

What are indirect manufacturing costs?

Indirect manufacturing costs include all other expenses incurred in manufacturing a product except direct expenses.

These indirect costs, also called factory or manufacturing overheads, include costs related to property tax, insurance, maintenance, and other indirect operations that support the production process.

According to a study conducted by McKinsey , these indirect costs account for 8% to 12% of the overall manufacturing costs.

Now that you are familiar with the components that constitute manufacturing costs, let’s move on to the process of calculating these expenses.

How to calculate total manufacturing cost?

Calculating the total manufacturing cost involves calculating the costs of:

• Direct materials,
• Direct labor,
• Other direct expenses, and
• Factory overheads.

Here is the simple formula to calculate the overall manufacturing cost :

Manufacturing cost = the cost of direct materials + direct labor + other direct expenses + factory overhead (manufacturing overheads)

Let’s go through all the steps for calculating total manufacturing costs. 

Step #1: Calculate the cost of direct materials

To calculate the cost of direct materials you need to know the cost of inventory. Let’s see how to find out the value of inventory.

First, collect cost information . Start by making a list of all the direct materials that are used to make the specific product and obtain the cost information for the direct materials you have identified. 

Next, calculate the value of the existing inventory if the manufacturing company already has a stock of materials from a previous period.

Then, add up the cost of new inventory — this is the cost of raw materials you purchase to manufacture the product.

Now, add the value of existing inventory to the cost of purchasing new inventory to calculate the cost of direct materials. 

From this, subtract the remaining inventory after manufacturing the product. This gives you the value of direct materials used, according to M.C. Shukla, the author of Cost Accounting: Texts And Problems .

For instance, let’s say a company has an existing inventory worth $1,500. 

The company purchases $1,000 worth of new materials to make product X.

Now, the total inventory value is:

$1,500 + $1,000 = $2,500

After manufacturing product X, let’s say the company’s ending inventory (inventory left over) is $500.

This means, the cost of direct materials is:

$2,500 – $500 = $2,000

Step #2: Compute the cost of direct labor

To calculate the direct labor cost, you will need to know the following:

• The total number of employees working on the production line,
• The total number of hours each employee works, and
• The hourly rate of labor.

To obtain these details, you can refer to the company’s employment records that has a list of all the employees and their hourly rates. 

Tracking the number of hours each employee works on the production line can be tricky. This is where a manufacturing time tracking app , such as Clockify, comes in handy. 

With Clockify, workers can quickly clock in and clock out.

As employees use Clockify to clock in and out, employers gain insights into the total number of hours each employee worked on each production line. You can also see the total number of hours worked by the entire team.

Once you know the number of hours worked by employees, you can calculate the cost of direct labor with this formula:

Direct labor = Hourly labor rate / the total number of hours worked on the production line by all employees

For instance, let’s say the hourly rate a manufacturing company pays to its employees is $30.

Here are the number of hours each worker worked:

• Worker 1— 6 hours
• Worker 2 — 7 hours
• Worker 3 — 9 hours

So, the direct labor cost per hour is:

$30 (hourly labor rate) / 22 (total number of hours worked) = $1.36

While this is a simplified view of direct labor calculation, accountants also include the benefits, overtime pay, training costs, and payroll taxes when calculating the hourly rate.

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Master labor cost calculations with smart tips and easy-to-use calculators. Read our blog post:

• How to calculate labor cost + labor cost calculators

Step #3: Add up the other direct expenses

The next step is to calculate the costs of utilities (electricity, water, or gas) that are directly used in the manufacturing process (for example, fuel used to operate the production equipment).

Step #4: Calculate the indirect costs (manufacturing overheads)

To calculate the indirect manufacturing costs you first need to identify all the indirect costs associated with the manufacturing process. 

These costs typically fall into categories such as: 

• Rent, 
• Utilities, 
• Depreciation, 
• Maintenance, 
• Supplies, 
• Insurance, and 
• Indirect labor (e.g., supervisors and quality control staff).

Once you identify the indirect costs, get detailed expense data for each of these overhead cost categories for a specific period, such as a month or a year. You can track expenses by looking at your invoices, receipts, and records of all expenditures related to manufacturing overhead.

Be sure to allocate overhead costs to the respective cost centers (specific departments, processes, or machines in the manufacturing facility that contribute to the manufacturing costs). 

For example, you can allocate depreciation costs of refrigerators to the department that uses them. 

Here is the breakdown of overhead costs of company Z that makes smartphones:  

Calculating the overhead cost for manufacturing one unit

While the calculation above gives you the total overhead costs, you will need to calculate the overhead cost for manufacturing one unit by using this formula:

Overhead cost of manufacturing one unit = Total overhead cost / number of units manufactured

For instance, if company Z makes 20,000 smartphones, the overhead cost (total indirect expenses) of manufacturing one smartphone:

$59,000 / 20,000 = $2.95

Knowing the overhead cost per unit is helpful in understanding what the manufacturing overhead costs will be if the company plans to double their production (in other words, make 40,000 smartphones) in the future, for instance.

Step #5: Calculate the total manufacturing cost

The last step is to calculate the total manufacturing cost by adding up all the above components: 

• Direct labor, 
• Direct materials, 
• Other direct expenses, and 

You will do that by using the total manufacturing cost formula we mentioned above:

Total manufacturing cost = Direct labor + direct materials + other direct expenses + manufacturing overheads

If this process of calculation looks complex, fret not. 

According to Francis Fabrizi , AATQB (The Association of Accounting Technicians Qualified Bookkeeper) at Keirstone Limited, there are specific tools that can help you streamline the calculation process:

“Some of the most popular options include:

• “Manufacturing ERP (Enterprise Resource Planning) systems that provide a comprehensive set of tools for managing all aspects of the manufacturing process, 
• Manufacturing Execution Systems (MES) that offer real-time data on the manufacturing process, and 
• Cloud-based cost accounting software which is a cost-effective way to track and manage manufacturing costs.”

The challenges of calculating manufacturing costs

Fabrizi also talked about the common challenges manufacturers face when calculating the costs of production. In his experience, the most common challenges are a lack of accurate data and the complexity of costing methods.

“Lack of accurate data as inaccurate data can lead to incorrect cost calculations, which can have a negative impact on the bottom line. Some costing methods are more complex than others which can prevent them from tracking and managing costs, making it difficult to get a clear picture of all of the costs involved in the manufacturing process.”

Fluctuation of costs is yet another challenge that makes it harder to calculate manufacturing costs accurately, according to Fabrizi.

What are examples of manufacturing costs?

Manufacturing costs are typically grouped under three categories:

• Direct labor, and 
• Manufacturing overhead. 

Let’s look at them in more detail.

Example #1: Direct materials 

Here are some examples of direct materials that contribute to manufacturing costs:

• Raw materials: these are the materials used in the production process. Raw materials become part of the finished product, such as wood used to make furniture, steel to manufacture appliances, or plastic used to make toys.
• Components: the cost of the individual components and semi-finished goods that are assembled to create the final product. For example, some car manufacturers buy individual components, such as car engines from other companies and assemble them. Semi-finished goods are those that have undergone some initial manufacturing steps but are not considered final products. An example is the fabric that has been cut and partially sewn into garment pieces but is not a complete piece of clothing yet.
• Packaging materials: the cost of materials used for packaging the finished product, such as boxes, labels, and other packaging materials.

Example #2: Direct labor  

Direct labor costs include the wages and benefits paid to employees directly involved in the production process of goods or products. 

Here are some examples of the different types of employees whose wages and benefits come under the category of direct labor costs:

• Assembly line workers: these are the employees who work on assembly lines, putting together various components to create the final product. For example, in an automobile manufacturing plant, assembly line workers are responsible for assembling different parts of a car.
• Machine operators: workers who operate machinery and equipment used in the manufacturing process. For instance, in a textile factory, machine operators oversee the operation of weaving machines or looms.
• Welders: skilled workers responsible for joining metal parts together through welding processes.
• Painters and finishers: workers responsible for applying paint, coatings, or finishes to products, such as furniture or metal components.
• Electricians and technicians: skilled technicians who install, maintain, and repair electrical systems and equipment used in manufacturing processes.

Example #3: Other direct costs

These are the expenses that are directly tied to the production of goods but may not fall into the categories of direct materials or direct labor. Here are some examples of other direct costs in manufacturing: 

• Energy costs: these include the costs of electricity, natural gas, and other forms of energy used to power machinery and equipment during the manufacturing process. For example, the electricity used to run machines in a steel mill.
• Tooling and setup costs: costs related to the setup of machinery and equipment for specific production runs, including the cost of tooling, fixtures, and molds.
• Subcontractor costs: manufacturing companies often outsource certain aspects of production or certain components to other companies. The fees paid to these subcontractors are examples of direct manufacturing costs. For example, an automotive manufacturer can outsource the production of car seats to another company.

Example #4: Indirect manufacturing costs (factory overheads)

Here are some examples of indirect manufacturing costs:

• Factory rent: the cost of renting the manufacturing facility where production takes place is an example of an indirect manufacturing cost.
• Utilities: expenses related to electricity, water, heating, and cooling used in the administrative office are considered indirect manufacturing costs.
• Depreciation: the reduction in value of manufacturing equipment over time is a form of indirect manufacturing cost.
• Taxes: indirect manufacturing costs will include the taxes that companies pay on the commercial property they use for manufacturing. Taxes will also apply to any equipment, machinery, computers, furniture, and tools used to manufacture the product.
• Insurance: manufacturers need to buy several types of insurance policies to protect themselves from risks, such as property damage, employee accidents or injuries, equipment breakdown, customer liability, and natural disasters.
• Fuel: the cost of fuel used in office cars or other forms of transportation is also counted as indirect cost.
• Indirect labor: a manufacturing unit typically involves many employees who are not directly involved in the manufacturing process but support the process indirectly. The wages paid to these employees will also come under factory overheads. Examples include supervisors, administrators, accountants, and human resources. 
• Indirect operations: there are many activities that do not directly involve physically transforming raw materials into the finished products but support the production process. Examples include maintenance, quality control, supply chain management, research and development, and so on. 

Learn the cost of quality and stop quality issues in their track with this insightful blog post:

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What are the benefits of calculating manufacturing cost?

According to the book Manufacturing Cost Estimating , the benefits of calculating the costs of manufacturing range from guiding investment decisions to cost control. Let’s take a closer look at these benefits.

Benefit #1: Assists in cost control 

Cost control, according to Fabrizi, is one of the top benefits of calculating manufacturing costs. 

“By tracking and monitoring costs, manufacturers can stay on top of their costs and avoid unexpected expenses.”

By calculating manufacturing costs, manufacturers can better understand the elements that are driving up costs while identifying the most economical way to manufacture a product.

For instance, if some raw materials are driving up costs, manufacturers can negotiate with other suppliers who may be willing to supply these materials at a lower cost.

Here’s an interesting case study on how manufacturing cost analysis helped a steel manufacturing company save costs. 

The company engaged a consulting firm to help them find out what factors were driving up manufacturing costs. By looking at the historic data on employee timesheets and purchasing costs, the firm was able to understand the areas that were increasing the total manufacturing costs. 

The consulting firm was also able to re-negotiate the manufacturing company’s contracts with poor-performing suppliers.

As a result, the steel manufacturing company was able to achieve a 10% reduction in manufacturing costs and save €1 million (approximately $1.7 million) annually.

Benefit #2: Helps make informed pricing strategies to stay competitive

By calculating manufacturing costs, companies can clearly understand the true cost of making a product. Based on this information, the company’s management can add a markup to determine competitive selling prices for their products.

For instance, Ford Motor Company has reduced the price of F-150 Lightning , its electric car, by $10,000. The company has been able to do so by consistently working on improving the efficiency of production and lowering manufacturing costs. For that purpose, the company used sensors to collect and analyze the cost of materials in real time to see how to optimize the costs.

As you can see, by collecting cost data and calculating it accurately, businesses can optimize cost management and set the right price for their products to gain a competitive advantage.

Benefit #3: Assess the profitability of a product

Calculating manufacturing costs helps assess whether producing the product is going to be profitable for the company given the existing pricing strategy.

According to a study titled The Impact of Cost Control on Manufacturing Industries’ Profitability , businesses can boost their profitability by controlling the costs related to:

• Labor, 
• Materials, and

Manufacturing cost calculation gives an accurate view of the costs allowing companies to eliminate irrelevant costs and optimize resource utilization to boost profitability.

Want to know how time tracking helps you maximize your earnings on every project? Check out our Clockify help article:

• How to track project profitability

Benefit #4: Assists in “make or buy” decisions

With a breakup of all the costs of manufacturing, management can decide whether it is more profitable to purchase certain parts or materials from a vendor or manufacture them in-house.

As an illustration, let’s look at the findings of a case study titled Saving the Company with Contract Manufacturing . 

A manufacturing company initially purchased individual components from different vendors and assembled them in-house. As the company decided to assemble the components themselves, they found that the costs of managing the assembly line and the transportation were increasing significantly.

As a result, the company decided to outsource production to a contract manufacturing company (a company that enters into a contract with the manufacturer to make certain components) instead of assembling components in-house. This resulted in a 30% reduction in manufacturing costs.

The key takeaway of this case study is that understanding the fluctuations in manufacturing costs can empower companies to make informed and timely choices between outsourcing and in-house production. These informed decisions help in maximizing productivity and profitability.

Benefit #5: Guides investment decisions 

Manufacturers can compare the costs of making a product using different manufacturing processes. This helps them understand the most efficient process and the investment they need to make for the selected process.

For instance, if the manufacturing costs are too high, these costs can create a dent in the company’s profit. In this case, the management can decide to stop the production of some goods and invest in developing new ones that have a lower cost of production.

FAQs about manufacturing costs

Have more questions on manufacturing costs? We’re here to help. Here are some frequently asked questions (FAQs) and answers that address key concepts related to manufacturing costs.

What are material costs in manufacturing?

Material costs are the costs of raw materials used in manufacturing the product. These materials become part of the finished product.

What are manufacturing costs also known as?

Another commonly used term for manufacturing costs is product costs, which also refer to the costs of manufacturing a product.

Is manufacturing cost an asset?

Yes. Manufacturing costs are recorded as assets (or inventory) in the company’s balance sheet until the finished goods are sold . 

Wondering what assets and balance sheets mean?

A balance sheet is one of the financial statements that gives a view of the company’s financial position, while assets are the resources a company owns. These assets have value and the company can sell them to earn revenue.

As the manufacturing process involves raw materials and finished goods, all of these are considered assets. The materials that are yet to be assembled /processed and sold are considered work-in-process or work-in-progress (WIP) inventory. 

WIP inventory is the sum of the cost of labor, raw materials, and overhead costs involved in manufacturing the product. Francis Fabrizi explains that the goods that are waiting to be sold are recorded as assets and once they are sold, they are recorded as expenses:

“When a manufacturer begins the production process, the costs incurred to create the products are initially recorded as assets in the form of WIP inventory.  

When the finished products are sold, the manufacturing costs are no longer considered assets. Instead, they are transferred from the inventory account to the Cost of Goods Sold (COGS) account on the income statement.”

To sum up, finished goods that are not yet sold are considered assets.

What is manufacturing cost vs. non-manufacturing cost?

Manufacturing costs are directly associated with the production of goods. On the other hand, non-manufacturing costs are expenses incurred outside of the production process, such as: 

• Marketing, 
• Sales, and 
• Administrative expenses.

What factors are related to manufacturing costs?

Many factors can influence manufacturing costs, such as:

• Production volume,
• Labor costs,
• The skill level and efficiency of labor,
• Equipment efficiency,
• Raw material prices, and
• Overhead costs.

Use Clockify to slash your costs

Effectively managing expenses in manufacturing isn’t just an option — it’s a necessity. 

In fact, you already know that labor costs can spiral out of control if you don’t meticulously monitor them.

Introducing Clockify — a time tracking tool that offers an accurate breakdown of your labor costs. In the example below, you’ll see the robust Summary report in Clockify that lets you:

• Filter reports by project, client, task, and status,
• Select the time range you want to get insights on,
• See time broken down by activity, and
• View calculated hourly rates.

With all this valuable information under your belt, you can better track manufacturing costs as they pertain to your workforce.

As a result, you’ll make informed decisions about future bids to clients and your internal cost calculations.

For this purpose, you can set up a budget for each project that:

• Shows you tracked hours for the whole team,
• Compares billable versus non-billable time, and
• Gives you insight into remaining resources for labor costs.

In case you’re spending too many resources on a task or project, the option to set budgets in Clockify will give you a detailed insight into how you can better balance those resources.

In the relentless pursuit of manufacturing excellence, every dollar matters, and every second counts.

That’s why you need a reliable partner to buddy up with and slash your costs.

Optimize your workforce, take control of inefficiencies, and watch your profits soar with team time tracking software.

Kavitha Simha is a productivity author and researcher, passionate about finding smarter ways to manage time. Combining her knowledge of multiple disciplines, she seeks to help others optimize their work-life balance, which she believes is the key to minimizing stress.

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Material Costs

Material costs refer to the expenses incurred by a business in acquiring the necessary raw materials and supplies to produce its goods or services. These costs are an essential component of a company’s overall production and operational expenses, directly impacting profitability and competitiveness. Understanding material costs and effectively managing them can significantly contribute to a business’s success.

Understanding Material Costs

Material costs encompass various aspects that play a crucial role in determining a company’s financial performance. Understanding these components can help businesses make informed decisions and optimize their operations for maximum efficiency and profitability.

When it comes to material costs, there are several factors that businesses need to consider. These factors include the cost of acquiring raw materials, transportation costs , storage costs, and any additional costs associated with handling and processing the materials.

One important aspect of material costs is the distinction between direct and indirect materials. Direct materials are those that are directly used in the production process and can be easily traced to the final product. On the other hand, indirect materials are those that are not directly used in production but are necessary for the overall functioning of the business.

The Basics of Material Costs

At its most fundamental level, material costs cover the expenses incurred by a business to acquire the raw materials required to produce its goods or services. This includes both direct and indirect materials necessary for the production process.

Direct materials are often the primary focus when it comes to material costs. These can include items such as wood, metal, fabric, or any other material that is transformed into the final product. The cost of direct materials is typically easy to track and can have a significant impact on the overall cost of production.

Indirect materials, on the other hand, may not be as obvious but are equally important. These can include items such as lubricants, cleaning supplies, or tools that are necessary for the production process but do not become part of the final product. While the cost of indirect materials may not be as high as direct materials, they still contribute to the overall material costs and need to be managed effectively.

Importance of Material Costs in Business

Material costs hold significant importance in business operations, as they directly impact the profitability and competitiveness of an organization. Efficiently managing these costs can help businesses maintain a competitive edge and enhance their overall financial health.

One of the key reasons why material costs are important is their direct impact on the cost of goods sold (COGS). The COGS is a critical metric that measures the direct costs associated with producing goods or services. By effectively managing material costs, businesses can reduce their COGS and improve their gross profit margin.

Furthermore, material costs also play a crucial role in pricing decisions . The cost of materials is a key factor that businesses consider when determining the selling price of their products. By understanding and managing material costs effectively , businesses can set competitive prices that attract customers while still ensuring profitability.

Another aspect of material costs that businesses need to consider is the impact on supply chain management. Material costs can fluctuate due to factors such as changes in commodity prices, availability of raw materials, or geopolitical events. By closely monitoring and analyzing material costs, businesses can proactively respond to these changes and minimize any disruptions to their supply chain.

In conclusion, material costs are a critical component of a company’s financial performance. By understanding the basics of material costs, businesses can make informed decisions and optimize their operations for maximum efficiency and profitability. Effective management of material costs can lead to improved profitability, enhanced competitiveness, and a stronger financial position for businesses in today’s competitive market.

Components of Material Costs

Material costs consist of various components, each playing a distinct role in the cost structure of a business. Understanding these components is essential to gain insight into the factors influencing material costs and devise effective strategies to manage them.

Direct Materials

Direct materials are the primary raw materials that are directly involved in the manufacturing or production process. These materials can be directly attributed to the final product and are integral to its composition and functionality.

Indirect Materials

Indirect materials, on the other hand, are not directly incorporated into the final product but are essential for efficient production or operational processes. These materials support the production process and can include items such as lubricants, cleaning supplies, or other maintenance materials.

Calculating Material Costs

Calculating material costs accurately is vital for businesses to understand their production costs and make informed decisions regarding pricing, budgeting, and inventory management. It involves a structured approach that considers various factors influencing material costs.

Steps in Calculating Material Costs

Calculating material costs involves several steps, starting with identifying the specific materials and their quantities required for production. This is followed by obtaining the costs per unit of each material and multiplying them by the required quantities. Summing up these costs provides the total material cost.

Factors Affecting Material Costs

Several factors influence material costs, including supply and demand dynamics, market conditions, inflation, transportation costs, and availability of raw materials. Adequately analyzing these factors helps businesses anticipate and adapt to changes in material costs.

Material Costs in Different Industries

Material costs can vary significantly across industries, as different sectors have distinct requirements and market conditions. Understanding the specific considerations in various industries is crucial for businesses to effectively manage their material costs.

Material Costs in Manufacturing

In manufacturing industries, material costs are typically a significant portion of the overall production expenses. These industries often require large amounts of raw materials and supplies for mass production, making effective management of material costs vital for profitability.

Material Costs in Construction

The construction industry heavily relies on material costs as building projects require various types of materials, such as lumber, steel, concrete, and fixtures. Price fluctuations in these materials can greatly impact construction projects and overall costs, necessitating careful monitoring and strategic procurement.

Material Costs and Pricing Strategies

Material costs have a direct influence on pricing strategies adopted by businesses. Effectively managing material costs while considering pricing dynamics is essential for maintaining competitiveness and maximizing profitability.

Impact of Material Costs on Pricing

Material costs significantly impact pricing decisions, as higher material costs may lead to an increase in the final selling price of the product or service. Businesses must strike a balance between managing material costs and ensuring competitive pricing to attract customers without compromising profitability.

Strategies to Manage High Material Costs

When faced with high material costs, businesses can employ various strategies to effectively manage and mitigate the impact on their operations. These include exploring alternative suppliers, negotiating volume discounts, optimizing inventory, implementing lean manufacturing techniques, and seeking cost-saving innovations.

Material costs are a crucial aspect of a business’s financial performance, directly impacting its profitability and competitiveness. Understanding the components of material costs, calculating them accurately, and effectively managing them are key steps for businesses to optimize their operations, control expenses, and maximize profitability. By adopting informed strategies and keeping a vigilant eye on changing market dynamics, businesses can ensure that material costs remain under control and contribute positively to their overall success.

The Ultimate Guide to Project Cost Management with Templates

By Kate Eby | April 25, 2017

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Your organization’s projects are critical to its future. Sound cost management enables you to make optimal use of your resources (time, personnel, equipment, and materials), make data-driven decisions about projects and their risks, measure financial performance, and provide key metrics to senior management.   This definitive guide to project cost management includes templates for key activities like cost estimating and creating a cost management plan. You’ll learn important terms, best practices, and subtle distinctions (such as the difference between cost management and strategic cost management), as well as how cost management works in specialized cases, like construction and IT projects.

What Is Project Cost Management?

Whether you are developing a new product, designing a facility, or changing a key process, it’s challenging to forecast and manage project costs effectively.   In fact, the job is so challenging that half of all large IT projects massively blow their budgets , running on average 45 percent over budget and seven percent over time, according to consultants McKinsey & Co. and the University of Oxford. For projects in other sectors, the news is no better. The Project Management Institute (PMI) reported in 2016 that companies were completing only 53 percent of projects within their original budget. However, strong cost management helps you avoid that fate. So what exactly is cost management?   Cost management refers to the activities concerning planning and controlling a project’s budget. Effective cost management ensures that a project is completed on budget and according to its planned scope. Since you assess the success of a project at least in part by its cost performance, cost management is a prime determinant of project outcome.   Cost management activities are conducted throughout the project life cycle, from planning and budget allocation to controlling costs during project execution and assessing a project’s cost performance upon completion.   Although cost management includes a whole ensemble of activities, it is sometimes referred to in terms of more specific functions, such as spend management, cost accounting, and cost transparency. Cost managers sometimes use these terms as loose synonyms for the broad cost management function.

Cost Management: Four Major Steps

The Project Management Body of Knowledge (PMBOK), the bible of project management theory, says cost management is made up of four processes. These generally adhere to the sequence that follows — as a project goes from the planning board to reality.

• Resource Planning: Part of the initiation stage of a project, resource planning uses a work breakdown structure — a hierarchical representation of all project deliverables and the work required to complete them — to calculate the full cost of resources needed to complete a project successfully. Managers typically determine required resources for each work breakdown structure component and then add them to create a total resource cost estimate for all project deliverables.
• Cost Estimating: Cost estimating is an iterative process that uses a variety of estimating techniques to determine the total cost of completing a project. Cost estimating techniques vary widely in their approaches to computing project costs, and stretch from conceptual techniques that draw mainly from historical experience and expert judgment to determinative techniques that estimate costs on a component-by-component basis. We will discuss these techniques in detail later, as they vary in their levels of accuracy. Determinative techniques are the most accurate; however, while the estimator’s job is always to create the most accurate estimate possible, determinative estimating techniques are only an option if you’ve reasonably finalized a project’s scope and deliverables. As such, you use the less accurate estimating techniques during the earliest stages of project planning, and then revise and update estimates as the project continues to be defined. To learn more about cost estimating, read The Ultimate Guide to Project Cost Estimating . 
• Cost Budgeting: Once you’ve created satisfactory estimates, you can finalize and approve the project’s budget. Cost managers typically release budgeted amounts in stages according to the level of a project’s progress. These allocations include contingencies and reserves.
• Cost Control: Cost control is the practice of measuring a project’s cost performance according to cost and schedule baselines that provide points of comparison throughout the project life cycle. The specific requirements for effective cost control are set out in the project management plan. The individual in charge of cost management investigates the reasons for cost variations - if they deem cost variations unacceptable, corrective action is likely. Cost control also includes other related responsibilities, such as ensuring that updated project budgets reflect changes to a project’s scope.

Key Components of the Cost Management Plan

The cost management plan guides these four processes. Created during the project planning phase, the cost management plan is a document that defines how you manage, control, and communicate a project’s costs in order to complete the project on budget.   Among other things, a cost management plan identifies the individual or group responsible for cost management, details how you will assess a project’s cost performance, and sets rules for how to communicate cost performance to project shareholders. It also establishes the methodologies by which you will control project cost variations.   While you can customize a cost management plan to fit your organization’s needs, they generally follow a standard format. Sections often include the cost variance plan, the cost management approach, information on cost estimation, the cost baseline, cost control, and reporting processes, the change control process, the project budget, and approvals. You may also want to include the spending authority levels for key project personnel, specifying which roles can approve costs up to specific thresholds.   Let’s look at the sections in greater depth:

• Cost Variance Plan: Cost variance is when the actual amount differs from the budgeted amount. In your cost management plan, you’ll need a section that details the actions you should take, including who is held responsible in the case of a cost variance. The size of the variance usually necessitates different action: a cost variance of less than five percent might result in an explanation of that variance, while a 95-percent-or-greater variance could force the project to be abandoned. To learn how to calculate cost variance, read Hacking the PMP: Studying Cost Variance . For a more detailed template on tracking schedule and budget variances, see this template:
• Cost Management Approach: This section outlines the approach a manager uses for cost management. The level of rigor can vary, but this describes how to establish a cost baseline and how to compare actual costs. You usually track and report costs through control accounts, where you roll up costs of subtasks. This often occurs at the third level of the work breakdown structure, a tool that breaks a project into small components or chunks of work to determine the resources needed to complete a job or project. However, the point at which you track and report depends on the scope of the project.
• Cost Estimation: Here you will define the methods used for estimating project costs, the levels of variation, and the expected precision, accuracy, and risk.
• Cost Baseline: This has a specialized meaning in project management and represents the authorized, time-phased spending plan against which you measure cost performance. It’s the sum of the estimated project cost and contingency reserves. 
• Cost Control and Reporting Process: This section establishes how you measure costs and their key metrics during the project. We’ll provide greater detail on this later.
• Change Control Process: This describes the process for making changes to the cost baseline and how to approve those proposed changes.
• Project Budget: The budget builds on the cost baseline by totalling the cost of executing the project (including contingencies for possible risks). It also adds in management reserves, which is an amount to cover unanticipated risks or unidentified events that may arise. An organization will usually set a policy for this, and the amount is often five to 15 percent of the total budget.

Cost Management Activities: Essential Functions at Each Phase

Cost management includes a number of activities conducted at different phases during the project life cycle. It’s important to include the cost management function while developing project plans so that you build solid financial controls into the project structure. Here are some key terms and stages relevant to cost management:   Planning: Using the work breakdown structure to determine the resources needed to complete a job or project.   Estimating: The act of calculating or predicting the expected total cost of completing a project.   Budgeting: The authorization of a budget based on a cost estimate to complete the project. You typically authorize budgets in tandem with schedules, so you can assess cost performance at specific points.   Financing and Funding: The process of requesting, authorizing, and receiving money for a project.   Cost Management: The general practice of overseeing project expenditures and making cost-related decisions throughout the project life cycle.   Controlling: Addressing cost variations to avoid cost overruns.   Job Control: Controlling project expenditure by comparing costs predicted by the cost estimate and costs actually being incurred.   Scheduling: You can determine a project’s cost performance by using a schedule that compares the expected expenditure to the actual costs the project is incurring at any point in time.   Accounting: The practice of recording expenditures and reconciling transactions.

How Accurate Project Cost Estimating Aids Cost Management Efforts

The first step towards robust cost management is having a clear idea of your project’s likely costs. However, it’s futile to track and control costs if you base your spending on unrealistic estimates.   Project estimating considers several variables, including the method you use to create the estimate, the stage at which you build your estimate, and the types of cost you include.     The first variable is the method you employ. You can produce cost estimates using a variety of estimating techniques, depending on the extent to which you define a project and the type of information you have access to. Here are some common estimation techniques:

Analogous Estimating: This uses historical data from similar past projects to create estimates for new projects. This method works if you have experience with projects of the same type.

Parametric Estimating: This method estimates time and cost by multiplying per unit or per task amounts by the total number expected in the project. The rates are often standard or publicly published rates and can be expressed in hours of work, amount of data entered, or the number of units of a product manufactured. This technique has a reputation for good reliability, but it’s less relevant when output isn’t uniform, such as when writing computer code. Some projects have widely varying or unprecedented tasks, so they do not lend themselves to this method.

Bottom-Up Estimating: This is a determinative estimating technique that estimates costs for work breakdown structure components and adds them together to create a cost estimate for an entire project. The project team members help create the estimate. Since the people who are going to be doing the work are engaged in estimating, professionals consider this method highly accurate, as well as a team commitment builder.

Three-Point Estimating: This is a PERT -related statistical method that uses the optimistic (lowest), pessimistic (highest), and most likely cost estimates to create expected values and standard deviations for project expenditures.

Software-Based Estimating: You can use software-based estimating techniques, such as Monte Carlo simulation, to model the effects of risk events on project costs.   Another factor influencing the cost estimating is the stage at which you build your cost estimate. As a project progresses, you discover more variables and actual costs, so project estimates become more refined. You can classify cost estimates based on how well you define the project scope at the time of estimation and on the type of estimation technique you use - the latter generally determines the accuracy of an estimate. In order of accuracy, the main classes of cost estimates are:   Order of Magnitude Estimates: These are very rough cost estimates based on expert judgment and on adjusting the costs of the current project to reflect the costs of similar, past projects. Created before fully defining projects, they are only used in high-level project screening.   Preliminary Estimates: A preliminary estimate uses somewhat-detailed scope information to form estimates based on unit costs. These estimates are accurate enough to use as the basis for budgeting.   Definitive Estimates: Created when you’ve fully defined a project’s scope, a definitive estimate uses deterministic estimating techniques, such as bottom-up estimating. Experts agree that definitive estimates are the most accurate and reliable.   The final variable affecting project estimation is the type of cost included. Of course, your project budget must include all the relevant costs for labor and materials, but whether you include a portion of your organization’s indirect costs depends on the policies of your organization and the type of project. Here are the terms experts use to distinguish between various types of costs:   Direct Costs: Direct costs are those which you can directly associate with a specific cost object. They are billable to specific projects.

Indirect Costs: You cannot associate indirect costs with a specific cost object, and you typically incur indirect costs by a number of projects at the same time. They are not billable to specific projects.

Fixed Costs: Fixed costs are costs you incur during manufacturing that are not associated with the volume of produced output.

Variable Costs: Variable costs are costs you incur during manufacturing that are directly associated with the volume of produced output.

Sunk Cost: A sunk cost is an expense you cannot recoup once it is incurred.

Opportunity Cost: When selecting a course of action, its opportunity cost is the loss of potential benefits from all alternative courses of action.

Costing Techniques Determine How to Account for Project Costs

A costing technique is the way in which you compute the total cost of producing a product or performing a task. Depending on the activity or activities being costed, you may use a variety of techniques. Here are some commons ones:   Job Costing: Managers use job costing, also called job-order costing, to determine the cost of a product that is unique or dissimilar to other products. In industries such as construction, it’s extremely rare for two jobs to be identical. Job-order costing uses a unique job-cost record that compiles total labor and resource costs, as well as applicable overheads, for each task or activity completed as part of a task to determine total expenditures for the job. The job-cost record includes both direct and indirect costs.   Process Costing: You use process costing to determine costs for products or tasks that are identical. Unlike job costing, it does not compute the total cost of a product by summing up the costs of all tasks and activities that go into creating the product. Instead, process costing looks at the processes included in the mass production that creates products. By dividing the total cost of a process by the number of units output, it is possible to determine the cost per unit of each process. After this, you may total the costs per unit of every process involved in the eventual manufacturing of the product. In this way, you compute the cost per unit of each product on a process-by-process basis.   Activity-Based Costing: Activity-based costing (ABC) is an approach to assigning overhead costs to products. Since overhead cost allocation based simply on the number of machine hours needed may be misleading, this costing technique looks at the activities focused on creating a product — testing, machine setup, etc. — and then assigns portions of their costs to all products created using these activities. Products that were not created via these activities do not have shares of these activities’ costs added on.   Direct Costing: Direct costing, also called contribution costing or variable costing, is a technique that only assigns variable manufacturing costs to the cost of a product. You do not add fixed manufacturing costs to the cost of creating a product but instead associate those costs with the time period during which you incur them.   Life-Cycle Costing: Life-cycle costing is a comparative analysis technique that involves summing the total costs incurred during the life cycles of project options in order to choose the best option. Since starting capital costs may not be an accurate representation of how much a project will eventually cost, life-cycle costing includes all costs associated with ownership — including maintenance and disposal costs — to enable better decision making. 

Measuring Project Performance With Cost Management KPIs

Once your budget is approved and your project is under way, you’ll want to benchmark your progress relative to your cost management plan. First, there are some key metrics and performance indicators to understand:     Project Cost Performance: A project’s cost performance is an assessment of how actual expenditure on a project compares with planned expenditure as detailed in the project budget. The project manager communicates a project’s cost performance to the project stakeholders, and it may serve as the basis for preventative or corrective actions to avoid cost overruns.   Earned Value: Earned value is a method of measuring project cost performance. It is based on the use of planned value (where you allot specific portions of a project’s budget to the project tasks), and earned value (where you measure progress in terms of the planned value that is earned upon completion of tasks). You may contrast the earned value with the actual cost -  the expenditure you actually incur up to a certain point in the project schedule - to see how actual project costs compare to expected project costs.   Cost Performance Index (CPI): This is a measurement of how earned value compares to actual cost. This ratio measures a project’s cost efficiency at a given point in time by expressing earned value in proportion to actual cost. To calculate CPI, divide earned value by actual cost. A result of 1 means the project is exactly on budget; a number above 1 means it is under budget.

To learn more about KPIs in project management, read All About KPI Dashboards .

How to Control Costs

Effective cost control means performing a number of related activities that all begin by monitoring costs — since you can’t know if costs are greater than planned unless you are tracking actual expenses. Then, project managers need to decide how to respond to cost variances. Here are some key steps and concepts that inform the cost control process:   Monitoring Cost Performance: A project manager routinely monitors a project’s cost performance by creating performance reports that summarize current performance and forecast whether you will complete the project on budget. You provide project stakeholders with information about a project’s cost performance.   Reviewing Changes: You must amend the cost baseline to reflect all cost-related changes, and you should inform the project shareholders about all changes.   Actual Costs versus Budgeted Costs: Upon milestone and entire project completion, you examine the variances between actual costs and budgeted costs. Responses to the cost management plan will depend on the magnitude of the variance and the stage of the plan - this could range from a discussion to changes in the project scope that reduce costs.   Reserve Analysis: Use reserve analyses to allocate contingency reserves to projects based on the likelihoods and magnitudes of risk.   Cash-Flow Analysis: Used in financial reporting, cash-flow analyses detail cash inflows and outflows over a given period of time, and provide starting and ending balances.   Learning-Curve Theory: The learning-curve theory applies to the relationship between the time spent producing a unit and the number of units produced. According to the theory, the time spent on each unit should decrease as workers gain experience and therefore produce units faster.   

Cost Management vs. Strategic Cost Management

While cost management reduces expenses regardless of their cause or purpose, strategic cost management is a sub-discipline that strives to manage cost while also making the organization stronger.    Robin Cooper, Professor of Management at Claremont’s Peter F. Drucker Graduate Management Center and Regine Slagmulder, Professor of Management Accounting at Tilberg University in the Netherlands, define strategic cost management as the “application of cost management techniques so that they simultaneously improve the strategic position of a firm and reduce costs.”   Strategic cost management centers on the idea that cost reduction initiatives can affect an organization’s strategic position. Strategic cost management emphasizes considering the strategic and financial impact of cost management techniques.   Cooper and Slagmulder classify cost management initiatives as one of three types based on how the initiative affects the organization:   Strengthen: An example of an initiative that strengthens competitive positioning is a taxi service that replaces its phone booking system and team of booking agents with an app that allows people to book taxis using their mobile devices. An initiative like this both reduces costs and gives a company a strategic advantage, as it makes it easier to book taxis on short notice.   No effect: An initiative that has no effect on competitiveness might concern a publishing house that outsources proofreading tasks to international freelancers who accept lower wages. While this increases the company’s profitability, it does not affect its strategic positioning.   Weaken: Finally, an initiative that actively harms competitive positioning might involve the taxi company decreasing the frequency of regular vehicle maintenance, a move which, while saving costs initially, will result in cars breaking down more often.   Strategic cost management also comprises a number of important strategies:   Relevant Cost Strategies: Use relevant cost strategies to compare and decide between alternative courses of action. Relevant costs are costs you can reduce by adopting a particular course of action. They are different from sunk costs (which you cannot recoup once spent) and fixed overhead costs (which are the same for all potential courses of action). When you make decisions, a relevant costs strategy focuses only on costs that vary among options.   Evaluating Opportunity Costs: Evaluating opportunity costs is a more holistic approach to decision making that considers not only all the monetary aspects of alternative courses of action, but also all the intangible aspects. For example, a company providing vehicle repair services might have to decide between two qualities of engine oil, taking into account both that one is more expensive than the other and that the more expensive engine oil also preserves engine health in the long term.   Balanced Scorecard Strategy: A balanced scorecard strategy allows businesses to assess the impact of cost management initiatives across four key areas: financial results, customer impact, internal business processes, and employee growth and development. It provides a framework for thorough consideration of the impacts of cost management initiatives. 

Getting Into the Details: Cost Accounting in Project Cost Management

Cost accounting involves the recording and classification of costs associated with a project. It is an internal practice that supports managerial decision making and is a primary discipline concerning cost management.

Cost accounting is different than general financial accounting. Financial accounting concerns  reporting an organization’s past financial performance and does not delve into extensive detail. Since you carry out cost accounting for a specific area of activity within a company — such as a particular project or geographical region — it focuses on more granular aspects and may include projections of future costs.   Cost accounting involves preparing reports for an organization’s management (these reports are not distributed externally). By contrast, financial accounting deals with standardized reports that may be distributed to a variety of stakeholders and regulators.   As such, you typically perform cost accounting on an as-needed basis, such as during a strategic project, and it does not follow a mandated format. Financial accounting, on the other hand, is a mandated and regulated formal process, and you must create financial reports according to international financial reporting standards.   There are a few commonly used cost accounting approaches:   Standard Cost Accounting: This is based on the concept of efficiencies , or ratios that compare the time and resource costs of actually completing an activity with the costs of completing the activity under standard conditions. Variance analysis is a core element of standard cost accounting. However, since the idea of efficiencies is based on a paradigm in which labor costs contribute substantially to manufacturing — which is no longer the case — standard cost accounting is somewhat outdated.   Activity-Based Costing: This is an approach to assigning overhead costs that examines activities that provide a service, execute a task, or create a product, and then assigns portions of their costs to output.   Resource Consumption Accounting (RCA): This approach emerged around 2000, and assigns costs based on the consumption of resources. It uses a German cost management system known as GPK and activity-based costing, a cost allocation method.     Throughput Accounting: This is an accounting approach that aims to maximize profitability by increasing the rate of production of goal units and minimizing operating expenses and investment costs.   Life-Cycle Costing: This is a method of analyzing project alternatives that focuses on total costs of ownership and selecting the most cost-effective option based on more than simple capital costs.   Environmental Accounting: Reporting the environmental costs incurred by a company or project’s activities.   Target Costing: This uses a predetermined market price and preferred profit margin to determine how much money can be used to create a product or service. The target cost is the maximum amount you can spend on production without affecting the profit margin.    Cost Coding: To make cost accounting easier, most organizations have adopted a method of identifying costs with a code, usually a number. The root of the code usually represents the type of expense, cost center, or business unit involved. This makes it easier to group and find related expenses in financial reports. Individual projects may be assigned their own code.   A common structure in an enterprise or very large organization is a top-level, four-digit code that relates to the accounting entity (for example, a subsidiary company). The next numbers pertain to department, followed by a number for the cost, which can be a cost center, profit center, work-breakdown-structure element, fund, or internal order. This facilitates the cost management process by aligning the cost codes with the work breakdown structure, which makes it easier to calculate financial performance.   In addition, costs in cost accounting may be classified by:  

• Traceability: Direct and indirect costs
• Behavior: Fixed or variable costs
• Controllability: Controllable or uncontrollable costs
• Time Incurred: Historical or predetermined costs
• Normality: Normal or abnormal costs
• Functions: The organizational function by which you incur a cost

  Cost accounts make it easy to identify cost overruns in specific sectors that might otherwise be lost in a budget overview. However, managing a large number of cost accounts — up to several hundred accounts and sub-accounts on larger projects — comes with its own challenges. It demands a higher degree of organization in accounting, for one, and classifying costs becomes more time consuming.   In addition, the system of categorization you use for a project’s cost accounts may not match up with the system of categorization you use for an organization’s cost accounts. This complicates the creation of a project budget from a final cost estimate, and is likely to happen when you create cost accounts using a system of categorization different than the performing organization uses.

Aside from recording historical expenditure, project managers must also forecast expected activity costs to ensure that they remain under control. Managers can do this through the use of tables that classify costs for individual cost accounts and cost modeling techniques that indicate whether work associated with a particular activity is due to be completed on budget.

Software’s Role in Project Cost Management

Cost management software simplifies and expedites project cost management activities. This can ease the burden on project cost managers and make it easier to extract insights, such as the cost performance index. Some of the common functionalities include:   Project-Tree Building: A visual representation of a work breakdown structure. This can be useful when employing deterministic estimating techniques.

Cost Estimation: Cost management software can provide powerful estimation capabilities such as using project trees to record activity costs, or running regression analyses to determine cost-estimate relationships in historical data.   Project Cost Management Templates: For projects that are similar, cost management ]templates can expedite cost management activities.   Budgeting: Cost management software can make it easier for project managers to conduct budget planning activities and allocate funding. 

Keep Projects On-Budget Using a Cost Management Template

One tool that can help with project cost management is Smartsheet, a collaborative work management and automation platform. As a cloud-based platform, you can share and collaborate on your cost management activities with internal and external stakeholders, and access the information from anywhere, on any device. 

Plus, with a pre-built, customizable template in Smartsheet, you can get started faster than ever. Track project and budget performance all in one sheet. Use symbols to quickly identify tasks that may be at risk of going over budget, and bring visibility to status of estimated versus actual labor, materials, and other costs. Set up alerts and reminders to notify you as costs change, and attach documents like invoices and purchase orders directly to tasks, to keep details in context.

Try one or all of the following templates to help ensure your next project stays on budget: 

Project Budget Template

‌ Download Project Budget Template

Excel | Smartsheet

Cost Management Plan Template

Download Project Cost Management Template

Activity Cost Estimate Template

Download Activity Cost Estimate Template

‌ Smartsheet Project with Schedule & Budget Variance Template

Cost Management for IT Projects

IT project costs are notorious for going over budget, mainly because of development approaches that allow scope creep during the product development life cycle. There is also a tendency for IT cost estimates to be less fixed than those of hard projects in fields such as construction and engineering, where maturity in planning and estimating is higher. In Information Technology Project Management , Kathy Schwalbe suggests that the people creating cost estimates for IT projects lack experience compared to specialist cost surveyors who create cost estimates for construction projects.   Furthermore, given how multifaceted these projects tend to be and how quickly IT evolves, IT projects often suffer from the “first-time, first-use penalty,” which means that it is hard to form accurate estimates when a project or project elements have not been attempted before. This makes documenting lessons learned crucial for IT projects.   The U.S. research and advisory firm Gartner creates a research report for the project and portfolio management market that categorizes vendors into four categories based on their ability to understand market needs and to drive the acceptance of new technologies. These are graphed on axes labeled “completeness of vision” and “ability to execute,” respectively. The “magic quadrant” is the upper right of this graph in which leaders in both areas cluster.  

Cost Management in Construction Projects

Construction project cost managers, or quantity surveyors, oversee cost estimation and cost control while maintaining a project’s profitability. They are responsible for ensuring that a project remains within budget while meeting its scope, quality, and performance requirements.   Though the majority of construction projects are not subject to the “first-time, first-use penalty,” they are still highly complex. And as hard projects, their design, scope, and budgetary requirements must be planned before work begins. Experience and formal training are essential for quantity surveyors.   The evaluation and recommendation of bids is one of the quantity surveyor’s primary responsibilities, though they may be engaged in a project from inception to conclusion. In fact, quantity surveyors get their name from the bill of quantities , a cost estimate prepared by the surveyor and by which contractors’ tenders are assessed.

To aid cost management for large, complex projects, quantity surveyors or project managers may use cost codes discussed earlier to set up multiple cost accounts. These accounts are essentially portions of budget marked for specific expenses such as labor, construction materials, architectural design, etc.

Home Construction Budget Template

Download Construction Budget Template

Excel |  Smartsheet

Construction Estimator Template

Download Construction Estimator Template

Excel  ‌| Word | PDF |  Smartsheet    

Exploring Cost Management as a Career

Professional cost managers, sometimes called quantity surveyors, work on large projects (such as construction). But project managers also need an understanding of cost management strategies and techniques to perform their duties.   Cost management requires creative problem-solving skills and a thorough understanding of the factors that affect project costs. As such, cost managers are in high demand and have opportunities to progress to lead project managers.   One popular cost management profession is cost accounting, which is determining the costs focused on creating a product or providing a service. Cost accountants deal with budget preparation and profitability analysis, and their main responsibilities include collecting and communicating cost-related data to aid management decision-making and create financial transparency.   Cost accountants typically study accounting or finance at the undergraduate level, and many pursue master’s degrees in business administration or finance with a specialization in accounting. They typically need a license to advance their careers, which can be obtained after meeting some combination of work and educational requirements.

How Smartsheet Can Help with Cost Management Across Your Projects

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Which Financial Statement Lists Raw Material Costs?

J.B. Maverick is an active trader, commodity futures broker, and stock market analyst 17+ years of experience, in addition to 10+ years of experience as a finance writer and book editor.

A company records its raw material costs on its income statement as part of operating expenses, and it usually lists them as costs of goods sold (COGS).

• Raw materials are grouped under the cost of goods sold (COGS).
• COGS appear on the income statement.

Raw Materials

Any substance or material used in the production or manufacturing of goods is considered a raw material. Raw materials are generally listed as COGS on a company’s income statement. They are part of a company's direct costs , along with labor.

Raw materials are grouped together under COGS, along with any other cost of producing a product, which not only includes labor but also manufacturing overhead.

Different processes may be used to modify raw materials before they can be utilized in the production of goods. Typically, raw materials are denoted as commodities, and many can be sold and purchased on commodities exchanges worldwide. Raw materials are vital to the process of manufacturing production and significantly impact the success of a country’s economy, based on the amount of natural resources existing within a country’s borders.

Raw Material Costs and Materials Requirement Planning

Raw material costs are critical for a manufacturer. Along with direct labor costs, raw material costs determine the basic profitability metric of gross profit margin. It is essential for a company to control its basic costs. This makes management programs such as materials requirement planning (MRP) very important.

MRP is a software-based information system created to help companies increase their levels of productivity. The system is rooted in sales forecasting and is used to more efficiently schedule the amounts and the deliveries of raw materials. MRP was among the first integrated information systems to utilize software technology and computers to offer productivity-related data to company managers. Production efficiency has greatly improved with the advent of such systems.

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• Write Your Business Plan | Part 1 Overview Video
• The Basics of Writing a Business Plan
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• 12 Reasons You Need a Business Plan
• The Main Objectives of a Business Plan
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• Write Your Business Plan | Part 2 Overview Video
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• How to Fund Your Business With an SBA Loan
• How to Fund Your Business With Bonds and Indirect Funding Sources
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• How to Use Your Business Plan to Track Performance
• How to Make Your Business Plan Attractive to Prospective Partners
• Is This Idea Going to Work? How to Assess the Potential of Your Business.
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• Write Your Business Plan | Part 3 Overview Video
• How to Write the Management Team Section to Your Business Plan
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• Use This Worksheet to Write a Product Description That Sells
• What Is Your Unique Selling Proposition? Use This Worksheet to Find Your Greatest Strength.
• How to Raise Money With Your Business Plan
• Customers and Investors Don't Want Products. They Want Solutions.
• Write Your Business Plan | Part 4 Overview Video
• 5 Essential Elements of Your Industry Trends Plan
• How to Identify and Research Your Competition
• Who Is Your Ideal Customer? 4 Questions to Ask Yourself.
• How to Identify Market Trends in Your Business Plan
• How to Define Your Product and Set Your Prices
• How to Determine the Barriers to Entry for Your Business
• How to Get Customers in Your Store and Drive Traffic to Your Website
• How to Effectively Promote Your Business to Customers and Investors
• Write Your Business Plan | Part 5 Overview Video
• What Equipment and Facilities to Include in Your Business Plan
• How to Write an Income Statement for Your Business Plan
• How to Make a Balance Sheet
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• How to Use Financial Ratios to Understand the Health of Your Business
• How to Write an Operations Plan for Retail and Sales Businesses
• How to Make Realistic Financial Forecasts
• How to Write an Operations Plan for Manufacturers
• What Technology Needs to Include In Your Business Plan
• How to List Personnel and Materials in Your Business Plan
• The Role of Franchising
• The Best Ways to Follow Up on a Buisiness Plan
• The Best Books, Sites, Trade Associations and Resources to Get Your Business Funded and Running
• How to Hire the Right Business Plan Consultant
• Business Plan Lingo and Resources All Entrepreneurs Should Know
• How to Write a Letter of Introduction
• What To Put on the Cover Page of a Business Plan
• How to Format Your Business Plan
• 6 Steps to Getting Your Business Plan In Front of Investors

How to List Personnel and Materials in Your Business Plan Manufacturers must show the labor and resources needed to run their business. Here's what you need to know.

By Eric Butow Oct 27, 2023

Opinions expressed by Entrepreneur contributors are their own.

This is part 11 / 12 of Write Your Business Plan: Section 5: Organizing Operations and Finances series.

Manufacturers combine labor and materials to produce products. Any problems with these critical inputs spell trouble for your business and its backers. Business plan readers look for solid systems to ensure that personnel and materials are appropriately abundant.

For this reason, your plan should show that you have adequate, reliable sources of supply for the materials you need to build your products. If you are working with suppliers in other parts of the world, show that they are reliable and that you have established a system to make such international production run smoothly. A global marketplace means more opportunities to find the materials or products you need and new markets for sales. This can be impressive to your readers.

Related: The Main Objectives of a Business Plan

However, you need to define and provide the details of how your business will benefit from being a part of the global marketplace. Even if you are not planning to actively pursue global partnerships, buy from vendors around the globe, or market to customers in other countries, you must address the possibility of international sales if you are selling via your website.

Estimate your needs for materials and describe the agreements with suppliers, including the length and terms you have arranged to fulfill those needs. You may also give the backgrounds of your major suppliers and show that you have backup sources available should problems develop.

Related: What Equipment and Facilities to Include in Your Business Plan

You'll first need to estimate the number and type of people you will require to run your plan. Startups can do this by looking at competitors' plants or by relying on the founders' prior experience at other companies. Existing firms can extrapolate what they'll need to expand from current operations.

Next, show that you can reasonably expect to be able to hire what you need. Look at local labor pools, unemployment rates, and wage levels using information from chambers of commerce or similar entities. If you plan to import sizable numbers of workers, check out housing availability and build an expense for moving costs into your budget.

Related: How to Craft a Business Plan That Will Turn Investors' Heads

More in Write Your Business Plan

Section 1: the foundation of a business plan, section 2: putting your business plan to work, section 3: selling your product and team, section 4: marketing your business plan, section 5: organizing operations and finances, section 6: getting your business plan to investors.

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Strategies For Small Businesses to Prevent and Mitigate the Risk of Rising Material Costs

Regardless of industry, rapidly rising or wildly fluctuating material costs can have a negative impact on a business. The same is true for material shortages, but those are usually managed via substitution or a simple delay. When shortages lead to a spike in prices, however, the result can be disastrous for business owners who may already be operating on thin margins. The goal of this article is to provide some strategies to prevent or mitigate the risk as well as protect from other, potentially unforeseen, expenses due to the rising price/shortfall situation.

Consider Adding a Price Escalation Clause to Your Contracts

The simplest way to protect from a sudden spike in costs is to include price escalation language in all contracts. Simply put, a price escalation clause provides that the contractor reserves the right to increase the price if there is a market-wide increase in the cost of a certain material over a certain amount or percentage, so that the contractor will be able to pass along that price increase.

Typically, price lock language is used for commodity type materials: steel, PVC, asphalt, concrete, etc. These terms are more common in longer term (multi-year) agreements but, given the current pricing and scarcity, have become more and more common in shorter term agreements.

It’s a good idea to meet with a business attorney who specializes in contracts and can give you the most protection in documents such as contracts, quotes, proposals, estimates, etc. It is also important for customers to pay attention to this language and ensure that a 10% increase in steel does not trigger a price increase of the entire job by 10% (since a job most likely consists of more inputs than steel alone!).

Many of these clauses are triggered only if the contractor cannot obtain the same or similar material for the index price (as stated in the agreement).

Make sure to explain the terms in agreements to your customer. Instead of burying language in the fine print, make sure the customer knows what they are signing. The conversation will go much better if the customer doesn’t feel blindsided and is made aware of the language up front. Providing a link to a short explanatory video or requiring acknowledgement as part of a digital agreement are some examples.

Price Escalation Clause Timing Considerations

Even with the inclusion of this language, timing is an important factor to consider. For example, many contracts are written months or years before work begins. The longer the time from contract signing to the price lock date, the more risk is carried by the contractor. For example, two parties may agree that any price escalation language only applies after the contractor breaks ground. Any material cost fluctuation from signing to groundbreaking is not part of the price escalation calculation.

Other business owners choose to provide a limited duration price lock. This is common in the trades or technology industry where adolescence, scarcity, and thin margins are a major factor. A paving contractor may issue a quote with pricing valid for only 30 days to protect themselves from any wild fluctuations in the price of asphalt caused by changes in the price of oil. We’ve also seen IT consultants provide quotes for as little as 14 days with a contingency for availability of the quoted item within X% of the quoted price. A price spike or the need to substitute a higher priced product due to a lack of supply would severely impact what is already a low margin industry.

Factor In Other Costs Related to Sudden Material Price Increases

Another aspect to consider is repeated trips. If scarcity or lack of staffing will require multiple trips (mobilizations to some industries), a smart business owner needs to factor that cost into the price. A plumber might typically block off one week for the rough-in work, and another for the finish work. But, if shortages of appliances and other items are going to require multiple trips or require the installation of temporary appliances, a business owner must consider this additional cost and include it in the pricing.

Change Your Materials Purchasing Model

Another strategy to handle rapidly changing prices is to change the purchasing model. A business owner who foresees a scarcity of an essential material and expects rising prices may want to lock in a fixed price/quantity contract for a period of time. The same applies for a business owner who expects a dramatic decrease in the price of materials in the future; this owner would only buy the quantity needed at that time to take advantage of the anticipated lower price in the future. Caution is needed with this strategy, however, as gambling on the market opens a business owner up to additional risk if the bet doesn’t go his/her way.

Build Up Reserves

While not specifically related to increased pricing, one way to minimize or prevent rapidly increasing prices from having a significant impact on the finances of the business is to increase reserves. Building up reserves (after paying down revolving debt) to can provide more cushion to weather the storm. A company with deep reserves can buy in bulk to delay the impact of rising prices. Or they can use those reserves to cover the sudden rise in prices and wait until favorable conditions in the market return.

It is important to have in place a plan and strategies for a sudden increase in material cost and to stay in tune with the marketplace when planning new projects. I hope that the above tips are helpful in mitigating risk due to fluctuating material costs in the future.

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How To Write a Business Plan for Building Materials Supplier in 9 Steps: Checklist

By alex ryzhkov, resources on building materials supplier.

• Financial Model
• Business Plan
• Value Proposition
• One-Page Business Plan
• SWOT Analysis
• Business Model
• Marketing Plan

Welcome to our blog post on how to write a business plan for a building materials supplier! With the growing demand for eco-friendly and sustainable building practices, this industry is experiencing significant growth. In fact, according to recent industry reports, the global green building materials market is projected to reach a value of over $595 billion by 2027, registering a CAGR of 11.2%.

Whether you're an entrepreneur looking to start your own building materials supply business or an existing supplier wanting to expand your offerings, a well-crafted business plan is vital for success. In this post, we'll guide you through nine essential steps to help you develop a comprehensive business plan for your venture.

Step 1: Identify your target market

Step 2: Conduct in-depth market research

Step 3: Assess your competition

Step 4: Define your unique selling proposition

Step 5: Determine your pricing strategy

Step 6: Outline your marketing and sales strategies

Step 7: Develop a detailed budget and financial projections

Step 8: Secure necessary funding sources

Step 9: Gather legal and regulatory information

Each of these steps is crucial for building a solid foundation for your business. By following this checklist, you'll be well-equipped to tackle the challenges and opportunities that come your way in the building materials supply industry.

Stay tuned as we dive deeper into each step in upcoming blog posts. Whether you're a seasoned business professional or a newcomer to the industry, this series will provide valuable insights to ensure your business plan sets you up for success.

Identify Target Market

The first step in writing a business plan for a building materials supplier is to identify your target market . This involves determining who your ideal customers are and understanding their needs and preferences. By clearly defining your target market, you can tailor your products and services to meet their specific requirements, which will increase the chances of success for your business.

When identifying your target market, consider factors such as demographics (age, gender, location, income level), psychographics (values, interests, lifestyle), and behavior (buying patterns, preferences, brand loyalty). This information will help you create customer profiles or buyer personas that accurately represent your target audience.

Tips for identifying your target market:

• Conduct market research to gather data on potential customers and their preferences.
• Observe the trends and demands in the construction industry, especially regarding eco-friendly and sustainable building materials.
• Utilize online tools and platforms to gather insights about your target market, such as social media analytics and keyword research.
• Consider surveying your potential customers to gain direct feedback and understand their pain points.
• Segment your target market into different groups based on specific criteria to create targeted marketing campaigns.

By identifying your target market and understanding their needs, you can develop effective marketing strategies, create compelling messaging, and differentiate your business from competitors in the building materials industry.

Conduct Market Research

Market research is a crucial step in developing a business plan for a building materials supplier. It involves gathering and analyzing data to understand your target market, industry trends, customer preferences, and competitive landscape. By conducting market research, you can make informed decisions and develop effective strategies to position your business for success.

Here are the key steps to conducting market research:

• Define your objectives: Clearly outline what you want to achieve with your research. Are you looking to identify potential customers, understand market trends, or assess the demand for eco-friendly building materials?
• Identify your target market: Determine the specific segment of construction companies and DIY renovators that you want to target. Consider factors such as location, size, and preferences.
• Collect primary research: Use methods like surveys, interviews, or focus groups to directly gather information from your target market. This will provide you with valuable insights into their needs, preferences, and buying behaviors.
• Collect secondary research: Explore existing data sources, such as industry reports, market studies, and competitor analysis, to gain a broader understanding of the building materials market. This information can validate your assumptions and provide context for your business plan.
• Analyze the data: Organize and evaluate the collected data to identify patterns, trends, and opportunities. Use statistical tools or software to generate meaningful insights from the gathered information.
• Identify market gaps: Determine areas where demand for eco-friendly and sustainable building materials is not being adequately met. This knowledge will help you position your business as a solution provider in those segments.
• Assess customer preferences: Understand the factors that drive customers to choose eco-friendly building materials. Consider aspects like price, quality, durability, and environmental impact. This knowledge will guide your product selection and marketing strategies.
• Evaluate the competitive landscape: Analyze your direct and indirect competitors to identify their strengths, weaknesses, and market share. Assess their pricing strategies, product offerings, and customer service to identify opportunities for differentiation and competitive advantage.

Tips for conducting market research:

• Start by exploring online resources, industry publications, and trade associations to gather preliminary information about the building materials industry.
• Consider leveraging social media platforms to engage with potential customers and gain insights into their preferences and pain points.
• Collaborate with industry experts, consultants, or research firms to gain access to specialized knowledge and resources.
• Regularly update your market research to stay informed about evolving trends and customer needs.

Assess Competition

Assessing the competition is a crucial step in developing a business plan for a building materials supplier. Understanding your competitors will help you identify gaps in the market and differentiate your business from others. Here are some important aspects to consider when assessing the competition:

• Identify Competitors: Begin by identifying your direct competitors, such as other suppliers of eco-friendly and sustainable building materials. Additionally, consider indirect competitors, such as traditional building material suppliers who may also offer green alternatives.
• Analyze Competitor Strengths and Weaknesses: Evaluate your competitors' strengths and weaknesses in terms of product offerings, pricing, marketing strategies, customer service, and brand reputation. This analysis will help you understand the areas where your business can gain a competitive advantage.
• Examine Market Share: Determine the market share held by your competitors and analyze their customer base. This information will give you insights into the market potential and help you plan your marketing and sales strategies accordingly.
• Gather Customer Feedback: Seek feedback from customers who have chosen your competitors' products or services. Understand the reasons behind their preferences and take note of any shortcomings mentioned. This information will guide you in refining your own offerings.
• Evaluate Pricing: Study your competitors' pricing strategies to determine if they are offering competitive prices for similar products. Assess whether you can offer better value without compromising on profitability.
• Regularly monitor your competitors' websites, social media platforms, and industry publications to stay updated on their latest offerings, promotions, and strategies.
• Consider attending industry trade shows and events where you can learn more about your competitors and meet potential customers.
• Find opportunities to collaborate with your competitors by forming partnerships or participating in joint marketing initiatives that benefit both parties.

By thoroughly assessing the competition, you will gain a clear understanding of the market dynamics, identify areas of differentiation, and make informed decisions that will contribute to the success of your building materials supply business.

Define Unique Selling Proposition

When it comes to running a successful business, it is crucial to understand what sets you apart from your competitors and why customers should choose your products or services. This is where defining your unique selling proposition (USP) becomes essential. Your USP is a statement or a combination of factors that make your business and products distinctive and appealing to your target market.

One of the first steps in defining your USP is to thoroughly understand your target market. Who are your ideal customers? What are their needs and pain points? By identifying their specific requirements, you can tailor your USP to address their concerns and position your business as the solution they are looking for.

To define your USP, consider the following:

• Identify your strengths: Determine your business's unique features, whether it's the quality of your products, your commitment to sustainability, or exceptional customer service.
• Research your competitors: Examine what your competitors are offering and how they position themselves in the market. Find a gap that you can fill or differentiate yourself by excelling in a particular aspect.
• Address customer needs: Your USP should directly address your target audience's pain points and provide a clear benefit or advantage that your competitors don't offer.
• Create a compelling message: Once you have identified your strengths and unique qualities, distill them into a concise and compelling message that clearly communicates the value your business brings to customers.
• Highlight your USP in marketing: Integrate your USP into all aspects of your marketing strategy, from your website and promotional materials to your social media campaigns and customer communications.

Tips for defining your USP:

• Focus on what makes your business stand out - whether it's the range of eco-friendly materials you offer or your personalized consultation services.
• Consider conducting surveys or gathering feedback from your existing customers to understand what they find most valuable about your business.
• Keep your USP simple and easy to understand. Avoid using technical jargon or complex terms that may confuse potential customers.
• Regularly reassess and refine your USP as your business evolves and customer needs change.

By clearly defining your unique selling proposition, you can differentiate your building materials supplier business and effectively communicate the value you provide to customers. This will not only help attract new customers but also build customer loyalty and long-term success.

Determine Pricing Strategy

When setting your pricing strategy as a building materials supplier, it is crucial to consider various factors to ensure profitability while remaining competitive in the market. Here are essential steps to help you determine the best pricing strategy for your business:

1. Cost Analysis: Begin by analyzing all the costs associated with your operations, including manufacturing or sourcing costs, transportation costs, storage costs, and overhead expenses. This will give you a clear understanding of your cost structure and help you set a baseline for pricing.

2. Market Analysis: Conduct a thorough market analysis to determine the price points at which your competitors are selling similar eco-friendly and sustainable building materials. This will provide insight into the current market trends and help you position your pricing strategy accordingly.

3. Value Proposition: Identify the unique selling points and value proposition of your eco-friendly building materials. Determine if your materials offer any additional benefits, such as durability or energy efficiency, which may justify a higher price point.

4. Target Market: Understand your target market's willingness to pay for eco-friendly materials and their purchasing behaviors. Consider the affordability and budget constraints of your potential customers when setting your pricing strategy.

5. Pricing Model: Decide on the pricing model that aligns with your business goals and customer preferences. You may consider options such as cost-plus pricing, where you add a markup to your costs, or value-based pricing, where you set prices based on the perceived value your products offer.

6. Discounts and Incentives: Consider offering introductory discounts, bulk purchase discounts, or loyalty programs to incentivize customers to choose your building materials over competitors. These strategies can help attract and retain customers while still maintaining profitability.

• Regularly review and adjust your pricing strategy based on changes in costs, market conditions, and customer feedback.
• Monitor your competitors' pricing strategies to ensure you stay competitive without compromising your profitability.
• Consider offering flexible pricing options, such as tiered pricing for different customer segments or customization options with varying prices.
• Do not undervalue your eco-friendly building materials; clearly communicate the value they bring to customers to justify your prices.

By carefully considering these factors and following a well-defined pricing strategy, you can strike the right balance between profitability and competitiveness as a building materials supplier. Remember to periodically evaluate and adapt your pricing strategy to ensure it remains aligned with your business objectives and meets the evolving needs of your customers.

Outline Marketing And Sales Strategies

Once you have identified your target market and conducted thorough market research, it is time to outline your marketing and sales strategies. These strategies will help you effectively promote your eco-friendly and sustainable building materials to construction companies and DIY renovators.

1. Define your target audience: Determine the specific demographic and psychographic characteristics of your ideal customers. This will help you tailor your marketing efforts and messages to effectively reach and resonate with them.

2. Develop a strong brand identity: Create a compelling brand image that reflects your commitment to providing eco-friendly and sustainable building materials. This will differentiate your business from competitors and attract environmentally-conscious customers.

3. Utilize online marketing channels: Establish a strong online presence by creating a user-friendly website, optimizing it for search engines, and leveraging social media platforms to engage with your target audience. Consider utilizing content marketing techniques such as creating blog posts, videos, and infographics to educate and inspire your potential customers.

4. Build strategic partnerships: Collaborate with construction companies, architects, and other industry professionals who share your values and target the same customer base. These partnerships can help increase brand awareness, generate referrals, and open doors to new opportunities.

5. Offer exceptional customer service: Focus on providing exceptional customer service to build strong relationships with your customers. This includes being responsive to inquiries, delivering orders on time, and offering personalized, knowledgeable assistance throughout the buying process.

Tips for implementing effective marketing and sales strategies:

• Regularly monitor and analyze the performance of your marketing campaigns to identify areas for improvement.
• Invest in search engine optimization (SEO) to increase organic visibility and attract qualified website traffic.
• Attend trade shows and industry events to showcase your eco-friendly building materials and network with potential customers.
• Establish referral programs or incentivize customers to recommend your products to others.
• Consider offering educational workshops or seminars on sustainable building practices to position yourself as an industry expert.

By outlining your marketing and sales strategies, you will be well-equipped to efficiently promote your eco-friendly and sustainable building materials, attract loyal customers, and contribute to the growing demand for green building practices in the construction industry.

Develop A Detailed Budget And Financial Projections

Developing a detailed budget and financial projections is a crucial step in creating a business plan for a building materials supplier. This step involves forecasting the financial aspects of your business and creating a plan to manage and allocate your resources effectively. By estimating your costs and projecting your revenue, you can identify potential financial risks and opportunities, and make informed decisions to ensure the financial success of your business.

When developing your budget and financial projections, it is important to consider all the necessary expenses and revenue streams associated with your building materials supplier. Here are some key aspects to consider:

• Operating Expenses: Identify all the costs involved in running your business, including rent, utilities, salaries, marketing expenses, and any other recurring expenses. It is important to be thorough and realistic in estimating these costs to create an accurate budget.
• Capital Expenses: Determine any initial investments required for equipment, machinery, vehicles, or inventory. These costs should be included in your budget to ensure proper allocation of funds.
• Revenue Streams: Assess your potential sources of revenue, such as sales to construction companies and DIY renovators. Determine your pricing strategy and estimate the volume of sales you expect to achieve. Consider any additional revenue streams, such as offering installation services or partnering with other businesses.
• Profit Margins: Calculate your projected profit margins by considering your costs and sales revenue. This will help you understand the profitability of your business and make adjustments if necessary.
• Cash Flow: Develop a cash flow projection to track the inflow and outflow of cash in your business. This is essential to ensure you have enough working capital to cover your expenses and maintain a healthy financial position.
• Use reliable financial analysis tools or software to facilitate budgeting and financial projections.
• Consider consulting with a financial professional to ensure accuracy and completeness of your budget and financial projections.
• Regularly review and update your budget and financial projections as your business evolves.
• Include contingency plans in your budget to account for unexpected expenses or changes in the market.

Developing a detailed budget and financial projections requires careful consideration and research. It is essential to ensure that your business is financially viable and sustainable in the long run. By accurately estimating your expenses and projecting your revenue, you can make informed decisions and effectively manage your resources, setting your building materials supplier up for success.

Secure Necessary Funding Sources

Securing funding is an essential step in launching your building materials supply business. Without sufficient capital, it can be challenging to finance inventory, equipment, marketing efforts, and other startup costs. Here are some crucial steps to take to secure the funding you need:

• Assess your financial needs: Before approaching potential funders, determine how much capital you require. Consider all the expenses involved in launching and operating your business, including product procurement, marketing, staffing, and overhead costs. Having a clear understanding of your financial needs will help you negotiate better terms with potential funders.
• Explore traditional financing options: Traditional financing options, such as loans from banks or credit unions, can be a viable choice for securing funding. Prepare a detailed business plan along with financial projections to present to potential lenders. Be prepared to provide collateral or personal guarantees, as they may be required by financial institutions.
• Consider alternative funding sources: If securing a traditional loan proves challenging, consider alternative funding sources such as angel investors, venture capitalists, or crowdfunding platforms. These sources may be more willing to invest in a sustainable and eco-friendly business model like yours. Research and reach out to potential investors who align with your values and mission.
• Seek out government grants and programs: Many governments and organizations offer grants and programs specifically designed to support sustainable and environmentally friendly businesses. Research and apply for grants that are relevant to your industry and business model. These funds can provide a valuable source of capital without the burden of repayment.
• Prepare a comprehensive and well-documented business plan that highlights the potential profitability and social impact of your sustainable building materials supply business.
• Network with industry professionals, attend conferences, and join relevant associations to connect with potential investors and funding opportunities.
• Consider partnering with strategic investors who can bring not only capital but also industry expertise and connections to help your business grow.
• Be prepared to negotiate the terms of funding, including interest rates, repayment schedules, and equity arrangements if applicable.

Securing funding for your building materials supply business may require persistence, patience, and a well-crafted pitch. Remember to demonstrate the potential for profitability and the positive environmental impact of your business to appeal to potential funders who share your vision.

Gather Legal And Regulatory Information

When starting a business as a building materials supplier, it is essential to ensure that you comply with all the necessary legal and regulatory requirements . Failing to do so can lead to fines, legal issues, and even the closure of your business. Here are some crucial steps to consider:

• Business Structure: Determine the most suitable business structure for your building materials supply business. Options include sole proprietorship, partnership, limited liability company (LLC), or a corporation. Each structure has its own legal and tax implications, so it's important to consult with a lawyer or accountant to choose the right one for your specific needs.
• Business Licenses and Permits: Research and acquire all the necessary licenses and permits required to legally operate your building materials supply business. This may include a general business license, sales tax permit, employer identification number (EIN), and any specific permits related to the handling and distribution of building materials.
• Environmental Regulations: As a provider of eco-friendly and sustainable building materials, it's important to understand and comply with relevant environmental regulations. This may include obtaining certifications or adhering to specific guidelines regarding the sourcing, production, and disposal of materials.
• Employee Laws: If you plan on hiring employees, familiarize yourself with labor laws and regulations to ensure compliance with hiring practices, wages, benefits, and workplace safety standards. Consult with an employment attorney or HR professional to stay up to date on any legal changes.
• Contractual Agreements: As a building materials supplier, you will likely engage in contracts with customers, suppliers, and contractors. It's crucial to seek legal advice to draft comprehensive and legally binding agreements that protect your rights and minimize any potential liabilities.
• Stay informed about changes in local, state, and federal regulations related to the building materials industry by regularly consulting with industry associations and legal professionals.
• Consider consulting with an attorney specialized in business and construction law to ensure you have a solid understanding of the legal landscape for your building materials business.
• Maintain accurate and organized records of all legal and regulatory documentation, including licenses, permits, contracts, and employee records, to demonstrate compliance and facilitate smooth business operations.

In conclusion, writing a business plan for a building materials supplier can be a complex process, but by following these nine steps, you can ensure that you are well-prepared to start and grow your business. Identifying your target market, conducting market research, assessing competition, defining your unique selling proposition, determining pricing strategy, outlining marketing and sales strategies, developing a detailed budget and financial projections, securing necessary funding sources, and gathering legal and regulatory information are all crucial aspects to consider.

By catering to the increasing demand for eco-friendly and sustainable building materials, you can position your business to take advantage of the growing market for green building practices. Remember to conduct thorough market research and assess your competition to ensure that your business stands out from the rest. Additionally, developing a solid financial plan and securing necessary funding sources will be vital for the success of your business.

Overall, a well-written business plan is a roadmap for success. It allows you to have a clear understanding of your target market, pricing strategy, marketing and sales strategies, and financial projections. By following this checklist, you will be setting yourself up for a strong start in the building materials supplier industry.

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How Much Does it Cost to Start a Business?

8 min. read

Updated April 25, 2024

What will it cost to start your business? This is a key question for anyone thinking about starting out on their own. You’ll want to spend some time figuring this out so you know how much money you need to raise and whether you can afford to get your business off the ground.

Most importantly, you’ll want to figure out how much cash you’re going to need in the bank to keep your business afloat as you grow your sales during the early days of your business. 

Typical startup costs can vary depending on whether you’re operating a  brick-and-mortar store, online store, or service operation . However, a common theme is that launching a successful business requires preparation.

And while you may not know exactly what those expenses will be, you can and should begin researching and estimating what it will cost to start your business.

• How to determine your startup costs

Like when developing your  business plan , or  forecasting  your initial sales, it’s a mixture of  market research ,  testing , and informed guessing. Looking at your competitors is a good starting point. Once you feel your initial estimates are in the ballpark, you can start to get more specific by making these three simple lists.

1. Startup expenses

These are expenses that happen before you launch and start bringing in any revenue. Here are some examples:

• Permits and Licenses: Every business needs a license to operate, just like a driver needs one to drive. Costs vary depending on industry and location.
• Legal Fees: Getting your business structure set up (sole proprietorship, LLC, etc.) might involve consulting a lawyer and at least will involve the basic business formation fees.
• Insurance: Accidents happen, and insurance protects your business from unforeseen bumps.
• Marketing and Branding: The ways to spread the word about your product or service. They could involve creating a website, creating business cards, or promoting social media.
• Office Supplies : Pens, paperclips, that all-important stapler – the essentials to keep your business humming.
• Rent/Lease: If you need to rent space for your business before you start selling, include those expenses in your list as well.

2. Startup assets

Next, calculate the total you need to spend on assets to get your business off the ground. Assets are larger purchases that have long-term value. They’re typically significant items that you could resell later if you needed or wanted to.

Here are a few examples:

• Equipment:  Think ovens for a bakery, cameras for a photography business, or computers for a tech startup.
• Inventory:  If you’re selling products, you’ll need to stock up before opening your doors (or your online store).
• Furniture and Decorations:  Desks, chairs, that comfy couch in the waiting room – creating a functional and inviting workspace might involve some upfront investment.
• Vehicles: If your business requires a vehicle to deliver your product or service, be sure to account for that purchase here.

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Why separate assets and expenses?

There’s a reason that you should separate costs into assets and expenses. Expenses are deductible against income, so they reduce taxable income. Assets, on the other hand, are not deductible against income.

By initially separating the two, you potentially save yourself money on taxes. Additionally, by accurately accounting for expenses, you can avoid overstating your assets on the balance sheet. While typically having more assets is a better look, having assets that are useless or unfounded only bloats your books and potentially makes them inaccurate. 

Listing these out separately is good practice when  starting a business  and leads into the final piece to consider when determining startup costs. 

3. Operating Expenses

Finally, figure out what it’s going to cost to keep your doors open until sales can cover expenses. Create a list that estimates monthly expenses, such as:

• Payroll (including your own salary)
• Marketing and advertising
• Loan payments
• Insurance premiums
• Office supplies
• Professional services
• Travel costs
• Shipping and distribution

Then, based on your revenue forecasts , calculate how many months it will take before your sales can cover all those monthly expenses. Multiply that number of months by your monthly operating expenses to determine how much you’re going to need to cover operating expenses as your business starts.

This number is often called “ cash runway ” and is a critical number – you need enough cash to fund those early red ink months. This number is how much cash you need to have in your checking account when you open your doors for business.

Calculating how much startup cash you need

To figure out how much money you need to start your business, add the asset purchases, startup expenses, and operating expenses over your cash runway period. This is your total startup costs, and it’s better to overestimate than underestimate these costs.

It often makes sense to invest the time to build a slightly more detailed starting costs calculation. Assuming you start making some sales and those sales grow over time, your revenue will be able to help pay for some of your operating expenses. Ideally, your sales contribute more and more over time until you become profitable.

To do a more detailed calculation, you’ll want to invest the time in a detailed financial forecast where you can experiment with different scenarios. If you do this, you’ll be able to see how much it will cost to start your business with different revenue growth rates. You’ll also be able to experiment with different funding scenarios and what your business would look like with different types of loans.

• Funding Starting Costs

You can cover starting costs on your own, or through a combination of loans and investments.

Many entrepreneurs decide they want to raise more cash than they need so they’ll have money left over for contingencies. While that makes good sense when you can do it, it is difficult to explain that to investors. Outside investors don’t want to give you more money than you need, because it’s their money.

You may see experts who recommend having anywhere from six months to a year’s worth of expenses covered, with your starting cash. That’s nice in concept and would be great for peace of mind, but it’s rarely practical. And it interferes with your estimates and dilutes their value.

Of course, startup financing isn’t technically part of the starting costs estimate. But in the real world, to get started, you need to estimate the starting costs and determine what startup financing will be necessary to cover them. The type of financing you pursue may alter your startup or ongoing costs in a given period, so it’s important to consider this upfront.

Here are common financing options to consider:

• Investment : What you or someone else puts into the company. It ends up as paid-in capital in the  balance sheet . This is the classic concept of business investment, taking ownership in a company, risking money in the hope of gaining money later.
• Accounts payable : Debts that are outstanding or need to be paid after a certain time according to your balance sheet. Generally, this means credit-card debt. This number becomes the starting balance of your balance sheet.
• Current borrowing : Standard debt, borrowing from banks,  Small Business Administration , or other current borrowing.
• Other current liabilities : Additional liabilities that don’t have interest charges. This is where you put loans from founders, family members, or friends. We aren’t recommending interest-free loans for financing, by the way, but when they happen, this is where they go.
• Long-term liabilities : Long-term debt or long-term loans.
• Other considerations for estimating startup costs

Pre-launch versus normal operations

With our definition of starting costs, the launch date is the defining point. Rent and payroll expenses before launch are considered startup expenses. The same expenses after launch are considered operating or ongoing expenses.

Many companies also incur some payroll expenses before launch because they need to hire people to train before launch, develop their website, stock shelves, and so forth.

Further Reading: How to calculate the hourly cost of an employee

The same defining point affects assets as well. For example, amounts in inventory purchased before launch and available at launch are included in starting assets. Inventory purchased after launch will affect  cash flow , and the balance sheet; but isn’t considered part of the starting costs.

So, be sure to accurately define the cutoff for startup costs and operating expenses. Again, by outlining everything within specific categories, this transition should be simple and easy to keep track of.

Your launch month will likely be the start of your business’s fiscal year

The establishment of a standard fiscal year plays a role in your analysis. U.S. tax code allows most businesses to manage taxes based on a fiscal year, which can be any series of 12 months, not necessarily January through December.

It can be convenient to establish the fiscal year as starting the same month that the business launches. In this case, the startup costs and startup funding match the fiscal year—and they happen in the time before the launch and beginning of the first operational fiscal year. The pre-launch transactions are reported as a separate tax year, even if they occur in just a few months, or even one month. So the last month of the pre-launch period is also the last month of the fiscal year.

• Aim for long-term success by estimating startup costs

Make sure you’ve considered every aspect of your business and included related costs. You’ll have a better chance at securing loans, attracting investors, estimating profits, and understanding the cash runway of your business.

The more accurately you layout startup costs and make adjustments as you incur them, the more accurate vision you’ll have for the immediate future of your business. 

Tim Berry is the founder and chairman of Palo Alto Software , a co-founder of Borland International, and a recognized expert in business planning. He has an MBA from Stanford and degrees with honors from the University of Oregon and the University of Notre Dame. Today, Tim dedicates most of his time to blogging, teaching and evangelizing for business planning.

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Norfolk Southern to Pay $310 Million for East Palestine Accident

The railroad company reached an agreement with the federal government to settle claims and costs from the 2023 derailment of a train carrying hazardous materials in the Ohio town.

By Peter Eavis

Norfolk Southern has agreed to pay more than $310 million to settle claims and cover costs stemming from the February 2023 derailment of a freight train carrying hazardous materials in an Ohio town, the federal government said on Thursday.

The Department of Justice and the Environmental Protection Agency said the settlement, which still needs to be approved by a federal court, would require Norfolk Southern to improve rail safety and pay for cleanup costs and health and environmental monitoring in and around East Palestine, Ohio, where the accident happened.

On a Friday night in early February last year, 38 rail cars on a Norfolk Southern train derailed, 11 of which were carrying hazard materials like vinyl chloride, a chemical used to make plastics. Days later, emergency responders, fearing an explosion, decided to release and burn vinyl chloride from derailed cars, sending vast plumes of dark smoke over the town. Hundreds of residents were evacuated, and life in East Palestine was upended for months. There were no deaths.

Michael S. Regan, the administrator of the E.P.A., said the settlement ensured that the cleanup would be paid for by the company and help prevent similar disasters.

“I committed to restoring the health and safety of the community, and I committed to holding Norfolk Southern accountable for the disaster it inflicted on the people of East Palestine and surrounding communities,” Mr. Regan said on a call with reporters. “And, folks, I am proud to say that today we are following through on those commitments.”

The biggest part of the settlement is an estimated $235 million to cover past and future costs relating to the environmental cleanup. About $15 million is a civil penalty related to claims that the railroad violated the Clean Water Act. Norfolk Southern did not admit liability in the settlement.

“We are pleased we were able to reach a timely resolution of these investigations that recognizes our comprehensive response to the community’s needs and our mission to be the gold standard of safety in the rail industry,” Alan H. Shaw, chief executive of Norfolk Southern, said in a statement.

The company said that it had already set aside money to cover the costs of the settlement. Overall, it expects to pay out $1.7 billion, a sum that includes a $600 million settlement of a class-action suit brought by residents and businesses that was announced last month.

The accident highlighted the dangers that freight trains pose and shined a harsh light on the rail industry’s safety practices. Investigators believe the Norfolk Southern train derailed after a wheel bearing overheated. Railroads place detectors on tracks to identify overheating bearings and alert employees to stop trains to prevent accidents. But the East Palestine train didn’t pass such a detector for nearly 20 miles, which meant that its overheated bearing was not identified in time.

Last year, lawmakers introduced a bill to bolster railway safety that, with some exemptions, requires minimum distances between detectors. But the legislation has not advanced in Congress amid stiff opposition from the industry.

Mr. Regan said the safety measures set forth in the Norfolk Southern settlement were informed by the legislation. It will require Norfolk Southern to have hot-bearing detectors 15 miles apart on tracks that commonly transport hazardous materials, which would cover a large part of the company’s network. The bill in Congress, with some exceptions, demands detectors every 15 miles on mainline tracks.

On a call with reporters, Mr. Regan said the safety measures were a “game changer.” And he contended that Norfolk Southern’s application of the measures would show that they were “doable, cost effective and technologically sound.”

The E.P.A. and Justice Department said Norfolk Southern’s safety improvements would cost over $200 million, an amount that is not included in the $310 million settlement. Norfolk Southern announced a safety plan soon after the derailment in which it said it would install approximately 200 hot bearing detectors.

Under the settlement, the railroad will spend $25 million over 20 years on a community health program, the bulk of which will be spent on medical monitoring. But the program will not cover the cost of treatments that might follow testing.

“Medical monitoring is not enough,” said Jess Conard, a speech-language pathologist who has worked as an activist in the East Palestine area since the derailment. “We need to be reassured that our exams, our treatments and any follow-up services will not make us go bankrupt.”

David M. Uhlmann, the assistant administrator in the E.P.A.’s enforcement office, said in an interview that the laws that formed the basis of the settlement — the Superfund law and the Clean Water Act — do not give the government the authority to recover health care costs.

The settlement does not resolve all regulatory and legal challenges faced by Norfolk Southern.

The state attorneys general for Ohio and Pennsylvania are still scrutinizing the company, and next month the National Transportation Safety Board will release its final report on the accident, which is expected to include recommendations for new safety regulations.

Before the accident, Norfolk Southern’s safety record had been deteriorating . But its accident rate improved markedly last year while those of other large U.S. freight railroads worsened .

Peter Eavis reports on the business of moving stuff around the world. More about Peter Eavis

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The doctor of a 114-year-old woman shares something we could all do to live longer — and it doesn't cost a thing

• Pearl Berg, who died this year, lived to be 114, the third oldest person in the United States and ninth oldest in the world. 
• Her doctor said she didn't have any extreme diet, exercise habits, or supplement routine.
• She was an example of the theory that strong social relationships boost longevity, as research suggests. 

One of the oldest people in the world made it well over the century mark without a strict diet of kale salads, expensive supplements, or even a specific exercise routine.

Pearl Berg was 114 years old when she died in February, making her the third oldest person in the US and the ninth oldest in the world, according to the Gerontology Research Group .

The extraordinary thing about her age and her impressive health over the decades was just how ordinary she was, according to Dr. Jeremy Lorber, a hematologist-oncologist at Cedars-Sinai Hospital in Los Angeles who worked with Berg.

"What I found somewhat remarkable was that there wasn't some odd or unusual thing that she did or didn't do," he told Business Insider. "It seemed like she just tried to live life to the fullest."

Extending lifespan is big business right now, exemplified in the multimillion-dollar regimens and cutting-edge technology touted by youth-obsessed entrepreneurs like Bryan Johnson . From longevity clinics to trendy supplements, brands (and influencers) are rushing to cash in on our desire to put off the inevitable — even if we have less power than we'd like to believe when it comes to postponing death.

"People who focus on longevity may find it a positive feeling to have a sense of control, even if it's not right for everyone," Lorber said. "A lot is luck - we don't choose the genes we're born with. I think people have misconceptions about how much control they have."

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In contrast, Berg had a flexible, common-sense approach to her lifestyle, particularly when it came to sweet treats, her son Robert said in a statement.

"She never smoked, only had a sip of wine once a week at most, drank freshly squeezed OJ every morning, ate very few fatty foods, and had only a modest amount of dessert," he said. "Although, when she was 102, some of those constraints lifted—she wanted dessert every day—and by 106, she was asking for candy every morning and afternoon."

What did stand out about her routine was her habit of maintaining a strong social network and sense of purpose, staying engaged in the community through her synagogue, book clubs, volunteer work, and other activities.

While basic health habits such as not smoking or drinking can make a difference, longevity is less about any single factor and more about keeping healthy relationships and staying engaged with the world around you, since getting older can often lead to a sense of isolation, Lorber said.

"It kind of reinforced my thinking that there isn't one magical thing to do or not do," he said. "The things I identified in her and other patients that live long and live well is maintaining purpose, adding things or doing new things in their life."

Why healthy relationships and simple routines are good for a long life

Like Berg's example suggests, some of the best strategies for a long, healthy life are free. Habits like maintaining strong relationships, taking time to relax, and getting regular, gentle exercise like walking, playing games with family, or gardening have been consistently linked to better odds of living to 100 (or older) without breaking the bank.

And overcomplicating your routine to optimize your lifespan can backfire, especially if you end up cutting out things you love or forcing yourself into a strict or stressful routine, according to Lorber.

"With all the books and podcasts trying to squeeze every extra hour out of life, you don't want to be hyper-focused on longevity and add interventions that reduce the quality of life," he said.

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