Total cost method: How to expose cost traps and increase your profits

The total cost method (TCO) provides a remedy. It provides you with a complete overview of all expenses in the company – and thus creates the basis for well-founded decisions and higher profits.

In this article, you will learn how to use the GKV to uncover cost traps, improve your profitability and secure your company’s competitiveness. We also show you the risks that arise when companies forgo the SHI – and for which sectors the method is particularly worthwhile.

What is the nature of expense method?

The nature of expense method is a method used in the income statement. It compares all expenses in a financial year with income – regardless of whether the goods produced have already been sold or are still in stock.

In contrast to the cost of sales method, the cost of sales method takes all cost types into account. This gives you a complete picture of your operating expenses and shows you how your resources are actually being used.

The advantages of the TCO for medium-sized companies

Visualize a detailed cost structure

The TCM breaks down expenses by cost type – for example materials, personnel or depreciation. This allows you to see at a glance which areas cause the highest costs. You can intervene in a targeted manner: for example, through better purchasing conditions, more efficient processes or optimized personnel deployment planning.

Control profitability

The GKV shows you exactly at which turnover your costs are covered. On this basis, you can adjust your prices or production volumes – an indispensable control parameter, especially when margins are low.

Recognize trends and fluctuations in good time

Regular SHI evaluations show you seasonal fluctuations and trends in cost development at an early stage. This allows you to remain capable of acting and avoid undesirable developments before they have a negative impact on your balance sheet.

Safeguard investments

The GKV provides reliable data for investment decisions. You simulate different scenarios and create a sound basis for making decisions on future investments.

Transparent planning and budgeting

Thanks to GKV’s comprehensive database, you can create well-founded budgets and forecasts. You recognize deviations at an early stage and can take countermeasures in good time.

What happens when companies do not use the TCO?

Many medium-sized companies do not use the total cost method – often because they shy away from the effort involved. The consequences are considerable:

Lack of cost transparency

Those who do not know what costs are actually incurred in the company are forced to make decisions based on gut feeling. Investments, price calculations and cost reductions are then based on assumptions instead of reliable data.

Unclear stock valuation

Without GKV, it is often unclear how much capital is tied up in the warehouse. Companies underestimate the actual inventory costs – which can lead to liquidity bottlenecks.

Hidden inefficiencies

Without complete cost transparency, cost drivers often remain undetected. Inefficient processes, high reject rates or excessive energy consumption are not recognized – and reduce the company’s competitiveness.

Difficulties with financing

Banks and investors demand transparent figures. Without precise data, the chances of obtaining favorable financing conditions decrease.

Mismanagement due to inaccurate stock levels

Too little stock can lead to so-called “stock-outs” – in other words, you cannot fulfill orders because goods are missing. This not only means a loss of sales, but also damage to your image and a loss of customer loyalty.

Too much stock is just as problematic: stock ties up liquidity and increases the risk of write-offs if it is no longer used. Both reduce the result.

In short, without GKV, companies run the risk of misjudging their economic situation – with negative consequences for growth and stability.

For which companies and sectors is the TCO particularly suitable?

The total cost method is particularly advantageous for these companies:

Manufacturing companies

Companies with their own production facilities benefit greatly from the GKV because it comprehensively maps all costs – including storage and manufacturing costs. This enables them to recognize how much capital is tied up in raw materials, semi-finished or finished goods and to manage their production efficiently.

Companies with seasonal business

Industries such as construction, agriculture or the textile trade are subject to seasonal fluctuations. The GKV helps to identify these, secure liquidity and avoid bottlenecks.

Companies with complex cost structures

Industries with many cost types – such as the chemical, mechanical engineering or food industries – need precise cost management. The GKV creates the necessary transparency for well-founded decisions.

Growing companies

Anyone expanding needs reliable data for secure investments. The GKV provides this basis for simulations and protects against wrong decisions.

The weaknesses of the TCO – and how to compensate for them

The total cost method offers many advantages, but also some limitations. These can be specifically compensated for:

No product cost analysis

The GKV does not show which costs can be allocated to individual products. You should therefore supplement it with cost unit accounting in order to evaluate the profitability of individual products.

Limited analysis of cost drivers

The GKV does not answer the question of why certain costs are incurred. Supplement your analysis with activity-based costing to delve deeper into the causes.

Difficult comparisons

Companies use different accounting methods. When making comparisons, ensure that data sets are standardized and comparable.

Delayed response options

The GKV provides figures retrospectively. Combine it with controlling tools that provide real-time data to react faster.

Inventory valuation can be time-consuming

It is particularly time-consuming for small companies to regularly evaluate stock levels. A functioning inventory management system or well-organized stocktaking is essential here.

Values are not product-related

The data from the total cost method cannot be used directly to calculate individual products. Additional calculation methods are required here.

Conclusion: Uncover cost traps and secure competitive advantages with the TCO

The total cost method offers you, as a financial manager in the SME sector, a solid basis for maintaining an overview of all expenses. You uncover hidden costs, make well-founded decisions and secure your company’s competitiveness. If you intelligently supplement the TCM with other methods, you will gain a real advantage – and steer safely through challenging times.

Register now free of charge: Our info webinar “Inventory 365”

Inventory 365 specifically extends the classic total cost method (TCO) – and integrates it directly into Microsoft Dynamics 365 Business Central.

Find out in our next webinar how you can use the total cost method to precisely record the value of your inventories – and why this is crucial for your profitability.

Register now for free.