Cost Accounting & Margin Analysis

You cannot price what you cannot cost. Cost accounting is the discipline of understanding what it actually costs to deliver a product or service — a prerequisite for pricing decisions, margin management, and strategic resource allocation.

Direct vs Indirect Costs

Direct costs (variable): Costs that can be directly traced to a specific product, service, or customer.

• Raw materials
• Direct labour (time spent on a specific job)
• Subcontractor costs for a specific engagement
• Commissions on a specific sale
• Freight and delivery for a specific order

Indirect costs (overhead): Costs that support the whole business and cannot be directly traced to a single product or service.

• Rent
• Management salaries
• IT infrastructure
• Marketing and brand
• Finance and HR

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Job Costing (Service Businesses)

For service businesses, each client engagement is a "job". Job costing tracks the actual cost of delivering each engagement.

Time-Based Costing

• Hourly cost per staff member = (Annual salary + employer costs) ÷ billable hours
• Multiply by hours spent on engagement
• Add direct costs (travel, software, subcontractors)
• Compare to revenue earned = Engagement gross profit

Effective Rate Analysis

Effective Rate = Revenue Earned ÷ Hours Spent

If your target rate is R2,500/hour and the effective rate is R1,800/hour — you are under-pricing, scope-creeping, or over-servicing. Each engagement should be reviewed to understand why.

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Gross Margin Analysis

Gross profit = Revenue − Cost of Revenue Gross margin % = Gross Profit ÷ Revenue × 100

Benchmark gross margins by sector:

Sector	Typical Gross Margin
Software (SaaS)	70–85%
Professional services	40–65%
Distribution/wholesale	15–30%
Manufacturing	25–45%
Retail	30–50%
Restaurants / food service	60–70% (on food only)

Gross margin below sector benchmark typically signals: pricing too low, input costs too high, or product mix weighted toward lower-margin lines.

Margin by Product / Service Line

Never rely on blended gross margin alone. Analyse by:

• Product category
• Service line
• Client segment
• Geography

The blended margin is the average — the underlying composition determines the strategy.

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Contribution Margin

Contribution Margin = Revenue − Variable Costs
Contribution Margin % = Contribution Margin ÷ Revenue

Contribution margin is what each unit of sale contributes toward covering fixed costs and profit. Used for:

• Break-even analysis
• Pricing decisions (minimum price = variable cost per unit)
• Product mix decisions (prioritise highest contribution margin per unit of constrained resource)

Break-Even Analysis

Break-Even Revenue = Fixed Costs ÷ Contribution Margin %

Example: Fixed costs R500,000/month, contribution margin 60% → Break-even revenue = R833,333/month.

Any revenue above break-even contributes directly to profit at the contribution margin rate.

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Overhead Allocation

When a business needs to understand the full cost of a product or service (absorption costing), overheads must be allocated.

Allocation bases:

• Direct labour hours (common in manufacturing and professional services)
• Direct labour cost
• Machine hours
• Square metres (for facility costs)
• Revenue (simple but can distort)

Overhead rate = Total overhead ÷ Total allocation base

Apply this rate to each product/service to determine its fully absorbed cost.

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Pricing from Cost

The cost-based pricing floor:

Minimum Price = Direct Cost + (Overhead Rate × Allocation Base) + Target Profit Margin

Important: Cost-based pricing sets the floor, not the ceiling. The ceiling is determined by what the market will pay (value-based pricing). Price as close to the value ceiling as the competitive environment allows, but never below the cost floor.

Price-Volume Trade-Off

Before discounting, model the volume required to maintain the same total contribution:

Volume to maintain contribution = Current Contribution ÷ New Contribution per Unit

A 10% price reduction on a 40% margin product requires a 33% increase in volume to maintain the same gross profit. This analysis should accompany every discount approval.