Your customers do not buy a product. They buy the value and utility that you put into your product. Value-added costs are what it costs your business to produce your products or provide your services. The three types of costs you incur are value-added costs, business value-added costs and non-value-added costs. Often the business value and non-value-added costs are higher than your value-added costs. Cost accounting identifies these costs and accounts for the actual amounts of these three types of costs. You can use this information to identify which business and non-value-added costs you can cut without affecting the quality of your merchandise or services.
Customers exchange their dollars for the value in your products or services. For manufacturing firms, value-added costs are the raw materials, direct labor, equipment and machinery expenses used in creating your products. Your value-added costs also include the costs of holding goods in work in process and storing finished goods. Retail value-added costs include the costs of purchasing your merchandise, transporting the merchandise and storing merchandise. Value-added costs are the activities that make money for your business.
Customers look at business value-added costs as part of the product or service costs. For you, business value-added costs are the indispensable indirect expenses of producing your products or selling your merchandise or services. However, business value-added costs do not add value to your product, merchandise or service. For manufacturing, retail and service businesses, business value-added costs are your administrative and selling expenses. Administrative expenses include your employee salaries and wages, building rent or mortgage expense and office supplies expense. Selling expenses are the commissions and advertising costs you pay. Manufacturing firms also include indirect labor as a business value-added cost.
In your customers' eyes, non-value-added costs do not add value to your product or merchandise. Non-value-added costs often have a negative return in that they increase your costs without adding value. Reworking defective products, product inspections and quality control are non-value-added costs. Overproduction leads to higher storage costs and increases your non-valued-added costs. Excessive time spent processing and expediting orders due to missed deadlines or defective production are non-value-added costs, as is production time lost from idle employees or machines.
If you have defective products, keep a line operator on hand to immediately rework it instead of waiting to make the repairs later. Replace outdated and worn out machinery and equipment that frequently breaks down and causes delays. Group together the inventory items you need to complete a job to eliminate time wasted looking for items. Order just enough inventory items to satisfy your production or retail demands while avoiding excess inventory. Excess production increases your inventory costs and the costs of warehousing and storing your products. Eliminating non-valued-added costs increases your profits with no added effort or expense on your part.