The solution of various economic problems needs cost figures different from what are available in the balance sheets, income-statements, etc. of the firm. The accounting cost figures serve the legal, financial and tax needs of the firm but are not directly very helpful for managerial decisions. For, the management needs costs in terms of their source, period, rate of change with respect to output, the degree of their controllability etc.
It must be pointed out that all types of costs do not matter much rather future costs matter most in managerial decision-making.
The other costs are relevant only if the management is to continue with its past or present policies in future too, and if the environment in which the firm operates remains unchanged. Further, only those costs which are affected by the decision of the management need be analyzed; while expenses that remain unchanged should be ignored in the decision-making process.
Cost of production provides the floor to pricing. It provides a basis for managerial decision with respect to the price the firm must quote to its prospective customers; in deciding whether to accept a particular order or not; whether to abandon an old or establish a new product line; whether or not to increase the volume of specific outputs; to use idle capacity or rent facilities to outsiders; and whether to make a particular product or buy it. There are no straight and simple rules for such decisions and it is necessary to study production and cost analysis thoroughly to arrive at these decisions. The costs which firms incur are payments to various factors of production and hence they indicate incomes of these factors also. An understanding of cost thus helps to understand the distribution of factor incomes as well.
We know that a particular cost behaviour is the result of many factors, some controllable while others non-controllable, by the firm. Just like production-function, we can also write a cost function. Cost function can be taken for the enterprise as a whole or for each of its departments, depending upon the requirement of the management using the cost function. Since determinants of cost vary from situation to situation and enterprise to enterprise, it is not possible to state any general set of determinants of costs. Each management must, therefore, have to identify for itself the various determinants relevant to that particular situation. However a few determinants, which seem important in modem business, are plant size, utilization of the plant, technology, prices of the various inputs, size of lot, stability of production level, management and labour-efficiency.
Making of effective and right decisions depends much on the proper calculation of costs. If different types of costs are not properly understood, the managerial decisions are bound to be wrong and misleading.