Cost allocation is the process of assigning shared or indirect costs to specific products, departments, projects or clients to determine their true profitability.
Cost allocation distributes indirect costs (overhead) across the business units, products or clients that benefit from them. For example, rent is a shared cost that benefits all departments - cost allocation assigns a portion of rent to each department based on floor space, headcount or revenue. Common allocation bases include square footage (for rent), headcount (for HR costs), revenue percentage (for shared services) and direct labour hours (for manufacturing overhead). Accurate cost allocation is essential for understanding true profitability at a granular level. Without it, you might think a product is profitable because its direct costs are covered by revenue, when in reality it is not contributing enough to cover its share of overhead. Activity-based costing (ABC) is a more sophisticated allocation method that assigns costs based on the activities that drive them. SortBooks supports cost allocation by correctly categorising expenses and enabling per-client, per-project and per-department cost tracking in Xero.
SortBooks helps with the bookkeeping behind cost allocation by connecting to your Xero account and using AI to suggest the right account for transactions sitting in catch-all accounts, learning from your own past coding. Instead of fixing cost allocation by hand, you review each suggestion, approve it, and SortBooks updates Xero, GST code included. Then ask the AI CFO about your numbers, using live Xero data.
Overhead refers to the ongoing costs of operating your business that are not directly tied to producing a specific product or service. It includes rent, utilities and administrative salaries.
Profitability measures your business's ability to generate profit from its operations. Key metrics include gross margin, operating margin, net margin and return on equity.
COGS represents the direct costs of producing or purchasing the goods your business sells. It includes raw materials, direct labour and manufacturing overhead but not selling or administrative expenses.
Operating expenses are the day-to-day costs of running your business, excluding COGS. They include rent, wages, utilities, marketing, insurance and administrative costs.
Contribution margin is the amount remaining from sales revenue after deducting variable costs. It shows how much each sale contributes toward covering fixed costs and generating profit.
Connect Xero, check the AI's suggestions and approve the changes. SortBooks updates Xero for you.