How should you allocate overhead costs?
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- Опубликовано: 21 янв 2018
- Dave Pratt, CEO Emeritus of Ranch Management Consultants, recommends that you only allocate an overhead cost to an enterprise if you would lose that cost completely if you stopped that enterprise.
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Yeah it's much harder to determine if one section of a business is losing you money or not. I own a food business and it takes us quite a bit of investigation to really know if something should be cut.
Great Advice and scenario! Thanks Kept your reasoning Simple!!!
Both options are giving you insites you need to make the correct business decisions so id argue you should do it both ways for a full picture, without doing it the first way you will never know that you could take your time, your truck and your rented hay ground and graze it for another 3k profit instead of a 2k loss incressing your business profit from 1k to 6k.
Effectively, the hay was a value add by increasing the utilization of an asset.
Would you also want to move the salary paid to self to the cow side, or are we assuming we get the income from another source?
Good question! If I'm only doing half the work, I figured I'd only pay myself half as much. That said, if I hire an employee who worked on both sides of the business and I would NOT make him 1/2 time if I stopped part of the business, then yes, in this example I should allocate all of his salary to the cattle. But the take away from this example is to NOT allocate cost unless you'd lose the costs completely when you stop that enterprise.
I'm assuming that if we want to make more money, we'd better do something to earn it. If I can hire someone to do the work on the cows side for $10K, than that's all I get to pay myself to do that work. If it would take $50K to get someone to do it, then I should pay myself $50K.
We shouldn't base the salary on what we need or want to make. We should base the salary on what the job is actually worth (what would I have to pay to hire someone else to do it?)
A lot of people forget that in calculating profit, all salaries, including the owner's, must be deducted as a cost. Profit is what's left after we've subtracted ALL of the costs.
So, as an alternative to allocating costs evenly to both enterprises resulting in one earning a profit and the other not, would you rather charge more of the cost to the cows so that the hay is also profitable?
By allocating cost as explained in the video you will be able to see which enterprise is truly profitable. This will help you in analyzing your operation to then make better business decisions.
Thanks for your question. The rule on allocating overheads is you either charge 100% of it or none of it. If you would lose the cost completely if you stopped doing the enterprise, then allocate the entire cost to that enterprise. If you would still have some of the cost, then it is a business overhead. In that case we don't try to split the cost between enterprises, we just assign it to the whole business...I'll be doing a video explaining that in the coming weeks.
It might be tempting to tweak percentages allocated to try to make one thing look better (of course it will also make another look worse) ... but the goal shouldn't be to make things LOOK good... it ought to be to actually make them good. To see what's really going on so that you can make things good, don't allocate overheads unless 100% of the cost can be assigned to the enterprise or division to which you want to allocate it.