Customer Profit and Capacity in Cost Accounting

By Kenneth Boyd

In cost accounting, a cost object is anything (a product line, a unit, a batch) that’s used to accumulate costs. A customer can also be a cost object. Looking at costs and profit per customer helps you make good decisions about your limited capacity and customer profit.

Technology allows companies to analyze data for many customers. Computer programs can easily separate and review lots of customer data on costs and profits.

Small companies may not have the technology for complex analysis. If that’s the case, customer analysis applies best to companies with a limited number of customers or those who have excellent homogeneous customer data.

Job costing collects data and analyzing costs by the job. It assumes that each job has a different combination of costs. Process costing assumes that each product is similar. In that case, you analyze costs by process, not by job.

With job costing, you see some customers who are more profitable than others, and that’s what you’re looking for. Job costing makes it easier to see key information. For example, the most expensive job — or the job that you didn’t estimate accurately — becomes obvious. Just review your job cost sheets.

A large amount of indirect costs can create problems. Indirect costs are allocated rather than traced to the product. As you’ve seen several times so far, you need good customer data to properly allocate costs. If you don’t have good numbers, you won’t allocate costs accurately. This issue affects both job costing and process costing.

The point is simply that different customers have different levels of profitability.

Because you have limited capacity, you want to do more business with the most profitable clients and less business with the others. So come up with some criteria to decide which clients are the ones you really want. You already know in your heart (or gut) that it’s true, and you just need to quantify it. Your most profitable clients are those that match the criteria you create.

Smart companies know who their ideal customer is. That’s the customer who wants the product and is willing to pay a price that makes the transaction profitable. After the company figures out who its ideal customer is, it plans marketing, production, and pricing.

Say you sell mountain bikes. You’ve sold them for a while, and you’ve paid attention to your customers. You notice that the people who most often buy the bikes live in the Mountain West of the United States. The majority of your buyers are professionals in their 30s and 40s. They use the bikes on weekends for recreation. A smaller percentage of your business is younger people who ride the bikes to school and work.

Your ideal customer is the professional who rides on weekends. He (more likely a male) is willing to pay $2,400 for that little titanium-framed number in your product line.

So you plan your marketing to target that group — male professionals who are weekend warriors. You price your product at a level you know they’re willing to pay (probably a higher price than a younger person would pay). That’s how you use your ideal customer profile to generate profit.