Accounting is the language of business. To make good business decisions you need to understand this language. Take for instance the difference between the cost of making your product and the cost to support the existence of your product. Both are vital information but mistaking one for the other could be very costly mistake.

Cost of making your product

The cost of making your product also called your product cost should consist of the cost you absolutely need to make your product available to the market. Due to the nature of the cost, it is often stored as an asset on the balance sheet statement until it is sold. This is an accurate depiction of how the cost behaves. Just like an asset, product cost has future value and should not be expensed right away.

So what happens if you include cost that are not absolutely needed to make your product? For starters, you do not know what it cost you to make your product. Product cost should be examined on its own merit. Knowing what it cost you to make a product, would help you examine if there are better more productive ways to create the same thing. It also helps you determine the profitability of each product on an individual basis. Adding cost that are not essential to making the product distorts this cost.

Cost to support the existence of your product.

On the other end of the spectrum, a business cannot exist with product cost alone. If this was so, there will be no such thing as a broke entrepreneur. Every product needs a support system and this is what we call your period cost. Unlike product cost, period cost is expensed at the time they happen. A good example of a period cost is marketing. We all know that marketing is the life blood of any business. While it is not part of your product cost, your business will not survive very long without it.

Also, note that period costs exist to support the product. This is key because I see a lot of financial statements with cost that have no bearing to any revenue stream. This is why it is very important to fully understand the way the cost in your business behaves. Accounting for cost in the wrong way, would lead to bad information and finally taking the wrong action.

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