What are Relevant Costs?
Relevant costs is a management term that describes costs that are specific to a business decision. So, it eliminates unnecessary data from the decision-making process. Another name for relevant cost is differential cost and it changes accordingly to the context.
On the opposite side there are the sunk costs, that have already been paid and therefore are considered irrelevant. And also the committed costs, which are the ones that must be paid in the future and cannot be avoided.
So, basically, relevant costs are the ones that impact decisions and are specific to the operation. But how does relevant cost impact your strategy and inventory? Let’s talk more about it in this article.
The types of Relevant Costs
Generally, you can divide your relevant costs into two main categories. The first one is the Future Costs, which contemplate the potential costs based on the decision for that negotiation. So, the future cost will change based on how you conduct your strategy.
If you have a future cost that won’t change with your decision-making, then it’s not a relevant cost but an irrelevant cost. Since it is the same with all the possibilities.
Then, there are the opportunity costs, that are the costs in lost opportunities on each decision. On other words, is the benefit that you accomplish from an option that you didn’t chose. Evaluate that is important to weight options against each other.
What can impact the Relevant Costs?
So, as we established, the relevant costs are the one that comes from decisions on the process. But what kind of decision can result in changes in costs? And how can you perceive that change while making the decision?
For instance, a decision that can impact your costs is to continue or close an operation. If the basis of the decision is the costs of that operation and it increases profitability.
Another decision for companies that manufacture or assembly products is producing or buying parts that compose the final item. Here you have the changes in costs related to making your own parts or buying from an outside producer.
Finally, relevant costs are also special orders, that are outside the fixed costs of production for that period. The cost changes because you need to manage material and labor that you didn’t expect to fulfill that order.
Costs of Manufacture
Costs of producing are part of the profit of a company and therefore, part of the relevant costs of each operation. Here are some of the costs in the general process of manufacture from the production to the selling step:
- Costs of material.
- Machinery and Maintenance.
- Production Schedule.
- Shut down.
- Emergency and Risk Management.
In conclusion, relevant costs are changes in cash flow that happens during an operation depending on the decisions. That means any additional amount that you pay for the negoatiation.
Also include any reduction on prices or production costs. Being so, the relevant costs are a direct factor of the revenue that you earn at the end of the process. Finally, you can identify changes in cash flow if the company’s bank statement after the decisions.