How can a business evaluate its costs?

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There are two widely-used methods that a business can use to evaluate its expenses: cost allocation and cost-benefit analysis. Cost allocation is whereby the business gives different prices to items. For example, if the business wants to build additional offices to accommodate new departments, it can allocate the construction costs according to the square foot. Another cost allocation method that the company can use is headcount. For example, a small business usually pays its employees the same income. If that organization wants to know how much is spent on salaries, it can count the number of workers and multiply that figure by the average income.

Cost-benefit analysis is whereby the company weighs the advantages and the expenses of a certain project. For example, the firm may want to buy new machines to improve production. First, the company will calculate the expected increase in output and revenues. Then, the firm will calculate the expected cost of maintenance and training to operate such machinery. The buying price of the machine is also included. If the long-term benefits of the machine outweigh the costs, the project is given the go-ahead.

Another way that a business can evaluate its expenses is by knowing the opportunity cost of foregoing one alternative over the other. For example, it may be cheaper to rent machinery instead of buying it. In such a case, the firm would rather rent than buy.

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