Cost forecasting or Cost estimates is another
important contribution in the area of cost function. Cost forecasting means
estimating the future cost of productiondepending on the present trend of the
total cost of production. The cost forecasting exercise is derived from the
cost function where we observe that there is a positive relationship between
total cost of production and total output of the firm. On the basis of this
relationship the cost forecasting model becomes,
C = f (Y)
where,
C = forecasted cost of production (dependent variable)
Y = forecasted output level (independent variable)
where both these variables are positively related.
SIGNIFICANCE OF COST FORECASTING
1.
With the cost forecasting results the financial
manager calculate what will be the future liability in order to get a
particular target in output in the future. This knowledge is highly essential
because the financial manager has to identify the rational sources of finance
from which finance can be obtained in the future.
2.
The strategy manager can decide what will be the
change in strategy of production after getting the knowledge about future
liability of the management and future liability can be understood from the
results of cost forecasting model
3.
The personal manager has to take a decision whether
labor-intensive technique or capital-intensive will be continue in the
business, understanding the future liability of the management derived from the
results of cost forecasting model.
TECHNIQUES OF COST FORECASTING
1.
Cost-output
technique
2.
Cost-time
technique
1. cost-output technique
In this cost forecasting model, the financial manager
is considering the time series data from which different combinations
between Total cost of production and Total output can be obtained. In this cost
forecasting model the manager is considering two economic parameters,
i.e., total cost of production and total
output of the firm. Therefore the manager has to consider two normal equations
in order to get the values of two unknowns in the model. The normal equations
are,
∑y = Nx + b∑x … (i)
∑xy = a∑x + b∑x2 …(ii)
where
y = total cost of production (dependent variable)
N = number of combinations
a = technological parameter (constant)
b = rate of change in total cost of production
x = total output (independent variable)
after solving the normal equations we get the values
of a and b which are plotted into the linear trend equation, i.e.,
Y = a + bX
where
Y = forecasted cost of production
X = forecasted output
2. cost-time technique
In this cost forecasting model the financial manager
is collecting the time-series data of different total cost of production against
different years of production. In this model the financial manager is
considering two parameters, i.e., Total
cost of production and Time parameter. Therefore the manager is considering two
parameters, i.e., total cost of
production and time parameter. Therefore the manager is considering two normal
equations in order to get the values of two unknowns in the model. The normal
equations are,
∑y = Nx + b∑x … (i)
∑xy = a∑x + b∑x2 …(ii)
where
y = total cost of production (dependent variable)
N = number of years taken into account
a = technological parameter (constant)
b = rate of change in total cost of production
x = time parameter (independent variable)
after solving the normal equations we get the values
of a and b which are plotted into the linear trend equation, i.e.,
Y = a + bX
where
Y = forecasted cost of production
X = forecasted time parameter
With the help of cost forecasting techniques the
financial manager can estimate future cost of production depending on the
present trend of the costing component on the basis of hypothesis that there
exists a linear relationship between Total cost of production and Total output
of the firm as far as total cost of production and time parameter are taken
into account.