Price to Cash Flow Ratio – Meaning, Formula and Interpretation
“Cash is King” say the bigwigs on Wall Street. That is why the valuation of shares is done on the basis of discounted cash flow model rather than discounted earnings model. The price to cash flow ratio provides an analyst with a shortcut for finding companies that have been undervalued in comparison to their cash […]
Causes for Cost Overruns in Infrastructure Projects
In the previous article, we explained the concept of cost overrun. We also explained how cost overruns have a negative effect on the finances of the entire project. However, it is strange that despite being so harmful to infrastructure projects, cost overruns are still ubiquitous. It is common for more than 50% of megaprojects to […]
Why is Short Selling a Dangerous Financial Strategy?
The term short selling is often seen in the news. This tactic is regularly used by well-known investors. They are also very public about the shares they have shorted. This prompts many retail investors to follow suit. While, it may be true that many funds and high net worth investors make a lot of money […]
Public-Private Partnership in Stadium Financing
In the previous articles, we have already seen that funding a stadium can be very difficult from a financial point of view. The financial aspects of stadium financing can be challenging regardless of whether the financing will be provided by the government or by private parties. It is important to note that stadium financing can […]
Conditional Pass-Through Covered Bond
In one of the previous articles, we studied about covered bonds. We discussed how covered bonds are considered to be safer as compared to asset-backed securities. We also explained how having double recourse makes covered bonds virtually risk-free and gives investors the confidence they require to invest their money even if they end up getting […]
Job order costing systems have a massive paper trail. They function on the basis of this paperwork. This creates a lot of complications. Companies have to employ a lot of clerical staff to sift through this paperwork and that adds to the overheads that job order costing is trying to minimize.
For every job, there are several documents like quotation, invoice, sales order, materials receipt, labour tickets and so on. They need to be classified and maintained. Of late, information technology has helped in this regard. ERP systems have the option of job order costing inbuilt in them. This helps companies manage their paperwork faster.
Job order costing is a very powerful concept in theory. But in practice, it is very complicated to implement. These difficulties are multiplied if the organization works out of multiple locations and conducts a wide variety of jobs.
In practice, it becomes difficult to measure the costs that are associated with a particular job. Information technology has helped in this regard too. With barcodes and RFID chips these difficulties can be negated. But these IT systems are expensive to purchase and maintain and add to overheads.
Job order costing allocates overheads based on an allocation base. This allocation base then leads to an allocation rate which results in overhead costs being allocated to different jobs. Many times companies do not choose the best allocation base. Rather politically powerful managers in the organization choose allocation bases in such a way that it suits their department. Because of the incorrect costing, there is wide-spread conflict and discontent amongst the other departments which end up being charged. Since choosing an allocation base is so subjective, it ends up creating political problems in the organization itself and hampers productivity.
One of the major disadvantages of job order costing is that overheads are based on estimates. At the beginning of a job, overheads are not accurately known. This system, therefore relies on the experience and expertise of certain professionals and on empirical data. Neither of these is a reliable measure.
Past overheads cannot be considered to be a measure of future overheads because prices keep changing. True, that the prices are adjusted to show the effect of inflation and deflation but empirics itself will show that empirical data is far from accurate. Instead, firms can work on more effective ways to find their overhead cost information by studying the current trends in the external marketplace.
Also, job order costing does not provide an effective way of controlling overhead costs. Estimates are usually for quotation purposes only. The management is aware that these quotations are seldom accurate and hence they cannot be used as a base for controlling overheads. There are other costing techniques which provide better control over the costs being incurred.
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