Accurate Costing Systems: Should I Make or Buy?

Nov 06, 2014

Bill and I recently taught a CPE course on building an accurate costing system. We will be teaching another seminar this upcoming Monday, November 10 and another in a few weeks on December 3. In our seminar, there were several individuals who were interested in doing make versus buy calculations. We were expecting people to have specific questions, but were surprised with how many struggled when it came to make vs. buy decisions.

In order to do this type of analysis, it is essential for you to know how much it costs to make a given product. If you do not have an accurate costing system, you cannot know what the true cost is to make a product. Let’s assume you do know this information and you know it costs you $35 to make widget xyz. Now assume you can buy this same widget for $32. Based on this information, the choice is simple. You should buy this item, right?

make vs. buyNot so fast! As with most accounting questions, the answer is: it depends. There are many qualitative factors to consider. For example, what is the lead time on receiving the products, the quality or the need for more storage, etc? If you overlook these important influences, you could lose customers.

And of course there are quantitative factors to contemplate. If you no longer make widget xyz, will the entire $35 go away? Most likely, no. A portion of that cost is most likely fixed factory overhead and without making up for the volume used by widget xyz, you will still have to absorb that fixed factory overhead.

One of the key issues in make vs. buy is not factoring in all of the pieces. Often times apples and oranges are compared which results in bad business decisions. Sometimes buying a product instead of making it can be a very smart decision, but make sure you consider all of the factors!

Categories: Cost Accounting