Сommon, or indirect, costs are costs that can’t be attributed to a product or process. These expenditures relate to a group of individual costs.
In this post, we’ll figure out what common costs are, how they correlate with other types of expenses, and how you can calculate them. Let’s start by answering how you can avoid these costs.
Are Common Costs Avoidable?
On average, a business has both avoidable and unavoidable costs. Avoidable costs are all the expenses you can eliminate. For instance, if you stop manufacturing one of your products, you will get rid of expenses on raw materials, labor, and so on.
However, even if you wipe out specific product lines, you’ll have to pay for rent, electricity, and water. These expenses are common costs. You bear them no matter what, which makes this type of spendings unavoidable.
One more point to consider is the difference between joint and common costs. Read on to learn how they correlate to one another.
Common Costs vs. Joint Costs
Though the terms “joint costs” and “common costs” are often used interchangeably, they have different meanings. Joint costs occur when one process or element results in outputting several goods. For instance, you can derive kerosene, fuel oil, gasolene from crude oil.
Common costs arise when a firm outputs several products. However, these expenses can’t be attributed to any of these products directly. For example, a manager's salary is a common cost. You can distribute it between several manufacturing processes, but it's not related to any of them.
The nature of common cost makes counting them difficult. To help you get your head around it, we’ve prepared three cost allocation formulas.
Common Cost Formula
Counting the sum of all of your common costs is not rocket science – just sum up expense items. Things get trickier when you find out how to cut these costs as you'll need to distribute them.
There are three ways to allocate common costs: stand-alone, incremental, and the Shapley value method. Let’s discover the formulas for them and crunch some numbers.
In this case, you distribute costs according to the percentage each department would have paid separately. Imagine that department A pays $900 for rent and a department B pays $1,500. The total sum for the departments is $2,400.
Then the company got a discount from a property owner and now pays only pays $2,000. To allocate this sum between two departments, count the percent each of them paid initially.
A stand-alone amount for the department A is $900/$2,400*100 = 37.5%.
A stand-alone amount for the department B is $1,500/$2,400*100 = 62.5%.
To count the sum after allocation, multiply the percentage of the new sum.
Department A’s payment after reallocation is 37.5%*$2,000 = $750.
Department A’s payment after reallocation is 62.5%*$2,000 = $1,250.
You can use this method if one of the costs is inevitable and the other is additional. For instance, the company's goal was to rent a workspace for department B. The adjoining room was vacant, and the firm decided to rent it and place department A there. In this case, you need to subtract the additional cost from the total amount:
$2,000 – $1,500 = $500.
So, now department B pays $1,500 and department A – $500.
If the workspace for a department A was the initial goal, the table turns:
$2,000 – $900 = $1,100.
In this situation, department A pays $900 and department B – $1,100.
Shapley value cost allocation Method
According to this method, you need to count two or more costs and calculate the average.
The payment for a department A would be ($500+$900)/2 = $700.
The department B would pay ($1,500+$1,100)/2 = $1,300.
Now you know how to calculate and allocate common costs. Let’s move on to practice and find out what kinds of costs you may encounter.
Common Costs in Business
The problem with creating a list of common costs is that they differ for various businesses. However, you can consider the following expenditures to be the common costs in most cases:
- phone and utilities;
- licenses and tax deposits;
- professional services;
- travel expenses;
- office and other administrative supplies;
- marketing budgets.
Marketing budgets are unavoidable costs. Still, you can cut these expenses by applying marketing automation services. Sign up with SendPulse to automate your email, web push, SMS, and chatbot marketing.
- The article “Joint and common costs: definition and differences” offers the precise explanation on how these two types of expenses correlate.
- In the post “Operating Expenses”, Entrepreneur lists indirect expenses.
Last Updated: 03.02.2021