Long Run Incremental Cost - LRIC
Categories: Accounting, Company Management
You just had a baby. Now, you’re paying for diapers and food and not much else. (Grandparents are buying more than enough toys and clothes.)
However, as the baby grows, new costs are going to come into play. School costs, fees for piano and tennis lessons, etc. And as the kid gets less cute, the grandparents will pick up fewer of the clothes and entertain bills. Plus, you eventually have to deal with college tuition and, uh...maybe some bail money along the way.
These costs are still off in the future. But you can predict them, if just in a general way.
Basically, that situation represents the same concept as long-run incremental cost. Businesses estimate the (mostly) predictable costs that a project will require as it moves forward in time.
Right now, your app design business just takes place in your basement, with you leaching off your parents’ WiFi. But as it grows, you’ll need office space, server capacity, new employees...all costs you can at least chart in a spreadsheet while your mom serves you a PBJ with the crusts cut off. You can lay out the long run incremental costs of your business.
Related or Semi-related Video
Cost Accounting: What is a Cost Driver?4 Views
and finance Allah shmoop What is a cost driver Old
All right people to be ableto fix something you need
to know what's wrong with it first right That's the
point of a cost driver I'LL think about an actual
driver You're on the highway and suddenly you hear a
loud crunch from underneath the car The car skids to
a halt smoke pouring out from under the hood Yeah
well engines air complicated things The mechanic has to be
able to identify what specific part broke so he can
fix it Otherwise every time you hear a rattle well
you have to ditch the entire engine and start over
Well the term cost driver can get used a couple
of different ways In one sense it refers to any
expense that contributes to the production of a company's product
Will cost drivers in this context or used to identify
specific items in a production process that contribute to the
expense of making that item Cost driver also gets used
to refer to the main expenses a product or at
least a handful of expenses that matter most well The
goal is to identify the most significant contributors to the
overall cost You own a cow candy bar factory to
make the bars you've incurred a series of expenses Well
there are the ingredients you know like a cow which
makes chocolate You got sugar and milk and nuts and
caramel You've also got the labor like the people actually
working the industrial mixing vat or driving stuff around on
forklifts And you've got things like kill the energy needed
to run all the machinery and heat up all the
sugar and chocolate and stuff and the cost of cleaning
all the mixing equipment After your employees lick the excess
you know gooey stuff off the mixing bowl thing Well
each item the chocolate to sugar the nuts the labor
the energy the cleaning all count as cost drivers They're
all drivers of the cost of making a candy bar
But you Khun drill down further to find the expenses
that really matter Like say that the sugar in that
candy bar makes up forty percent of the cost of
producing that candy bar Well that makes it the main
cost driver for that product That candy bar Well the
cost of the chocolate might go up but it doesn't
really matter because well that Takao is only five percent
of the total cost of that candy bar But if
the cost of sugar goes up well that could really
hurt the bottom line Well individual cost drivers can include
many distinct categories of expenses Labor utilities transportation insurance raw
materials advertising interest expenses complimentary raw oyster bar for the
break room Any of these things can become cost drivers
Well you Khun further categorise these cost drivers into what
are called cost pool's think animals Cost drivers are like
individual species Draft for Angela's and hammerhead sharks Cost pools
are like the broader animal classes like mammals a racket
IDs and fish So electricity water an Internet costs or
connectivity costs are each potential cost drivers But you can
also group them together in cost fools of utilities Identifying
cost drivers allows companies to find ways to maximize profitability
well back to the candy bar Since sugar makes up
forty percent of the cost of these candy bars well
if you can lower the cost of that sugar you
could really increase profits You could change your recipe maybe
to use less sugar and more chocolate which would lower
your dependence on sugar Or you can replace sugar with
a substitute like a sweetener You know one of your
scientists cooked up in a lab if that sweetener is
cheaper than sugar well maybe you've just significantly lowered your
expenses but you only know to focus on lowering sugar
costs because you did the work to find out that
sugar was in fact your primary costs driver Will companies
track expenses as closely as possible to give category separate
in order to make these determinations like say you discover
that the chocolate your employees have been licking off the
equipment really leads to a big drop in inventory So
you put in place a zero licking policy enforced by
electrodes in the equipment They give a little discouraging shock
when they come into contact with the human tongue Electrocution 00:03:56.56 --> [endTime] or no chocolate life is full of tough decisions