Key Concepts

Karibu! Welcome to the Engine Room of Business!

Habari yako, mwanafunzi? Welcome to the exciting world of Management Accounting! Forget just counting money at the end of the year for the taxman (that's Financial Accounting). We are going *inside* the business. Think of yourself as a business doctor, using numbers to check the health of a company and help its managers make smart decisions every single day. From a small *kibanda* selling *chapatis* in Ngara to a big company like Safaricom, these concepts are the secret to success. Let's get started!

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1. The Foundation: What is a 'Cost'?

In simple terms, a cost is what you give up to get something. In business, it's the money spent to produce a product or offer a service. But here's the interesting part: not all costs are the same! To be a good manager, you must understand how to classify them. The most important way is by how they *behave*.

> Image Suggestion: [A vibrant, colourful illustration of a busy Kenyan street market scene. In the foreground, a friendly-looking woman (mama mboga) is selling fresh vegetables at her stall. In the background, there's a matatu, a boda boda rider, and a small duka (shop). The style should be modern and cheerful, reflecting Kenyan energy.]

a) Cost Behaviour: How Costs React to Change

Imagine you run a *boda boda* business. The number of trips you make in a day is your 'activity level'. Let's see how your costs react as you get busier.

• Fixed Costs (FC): These are the stubborn costs! They stay the same no matter how busy you are. Whether you make 1 trip or 50 trips, you still have to pay them.
  • Your monthly motorbike parking fee.
  • The annual insurance cost for the *boda boda*.
  • The county council business permit fee.
• Variable Costs (VC): These costs are your business partners. They go up when you are busy and go down when you are quiet. They change directly with your activity level.
  • Petrol (Fuel): More trips = More petrol used.
  • Airtime: To call customers. More customers = More airtime.
  • Oil and minor service costs that depend on mileage.
• Mixed Costs (or Semi-Variable Costs): These are a mix of both! They have a fixed part and a variable part.
  • Your electricity bill from KPLC: There's a fixed monthly charge even if you use zero power, plus a variable charge for every unit you use.
  • A salesperson's salary: A basic fixed salary (e.g., KES 15,000) plus a commission for every sale they make (variable).

Let's visualize the main two cost behaviours:

    Cost (KES)                          Cost (KES)
      ^                                   ^
      |                                   |  /
      |                                   | /
      |-----------  (Fixed Cost)          |/  (Variable Cost)
      |                                   /
      |                                  /|
      +----------------> Activity        +----------------> Activity
    (e.g., Rent)                        (e.g., Fuel)

The total cost of your business is a simple, powerful formula:

Total Cost = Total Fixed Costs + (Variable Cost per Unit × Number of Units)

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2. Where Does the Cost Belong? Functional Classification

Now, let's think like an accountant preparing reports. We need to group costs based on the job they do in the business. Imagine a local furniture workshop in Gikomba that makes beautiful wooden chairs.

a) Product Costs

These are all the costs needed to *make* the chair. They are "attached" to the product. They are also called manufacturing costs.

• Direct Materials: The main ingredients you can easily trace to the chair.
  • The wood (mahogany, pine).
  • Nails and screws.
  • Varnish.
• Direct Labour: The wages of the people who physically build the chair.
  • The salary of the *fundi* (carpenter) who cuts the wood and assembles the chair.
• Manufacturing Overhead: All other factory costs that are not direct materials or direct labour, but are necessary for production.
  • Rent for the workshop in Gikomba.
  • Salary of the workshop supervisor (who doesn't build chairs but manages the *fundis*).
  • Electricity to power the saws and tools.
  • Depreciation of the cutting machine.

b) Period Costs

These are costs that are not related to making the product. They are related to the 'period' of time (like a month or year). They are also called non-manufacturing costs.

• Selling Costs: Costs to get the customer and deliver the product.
  • Advertising the chairs on a Facebook page.
  • Salary of the salesperson at the showroom.
  • Cost of hiring a 'pick-up' to deliver a chair to a customer in Westlands.
  • M-Pesa Paybill charges.
• Administrative Costs: Costs to manage the entire organization.
  • The salary of the business owner/manager.
  • The accountant's fees.
  • Office supplies like paper and pens for the main office.

Here's a simple diagram to help you remember:

                 +-----------------------+
                 |      TOTAL COSTS      |
                 +-----------+-----------+
                             |
           +-----------------+-----------------+
           |                                   |
 +---------v---------+               +---------v----------+
 |   PRODUCT COSTS   |               |    PERIOD COSTS    |
 | (Inside Factory)  |               | (Outside Factory)  |
 +-------------------+               +--------------------+
           |                                   |
 +---------+---------+               +---------+----------+
 | Direct Materials  |               |   Selling Costs    |
 |   Direct Labour   |               | Administrative     |
 |    Manufacturing  |               |      Costs         |
 |      Overhead     |               +--------------------+
 +-------------------+

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3. Key Concepts for Smart Decisions

These next ideas are what separate a good manager from a great one! They help you make choices.

• Opportunity Cost: This is the most powerful concept you might not have thought about. It's the value of the next best alternative you give up when you make a choice. It's a "what if" cost.

  Scenario: You have KES 100,000. You can either (A) start a chicken farming business that you predict will make you a profit of KES 30,000 in the first year, or (B) put the money in a SACCO that guarantees you KES 10,000 in interest.
  
  If you choose to start the chicken farm, your Opportunity Cost is the KES 10,000 interest you gave up from the SACCO. You must be confident your farm will make more than this to justify the risk!

• Sunk Cost: A sunk cost is money that has already been spent and cannot be recovered. It's like water that has already flowed under the bridge. A smart manager ignores sunk costs when making future decisions.

  Scenario: Your favourite football team, Gor Mahia, is playing at Kasarani. You bought a non-refundable ticket for KES 1,000 last week. On the day of the match, you get very sick. You feel bad about "wasting" the KES 1,000.
  
  The KES 1,000 is a sunk cost. It's gone, whether you go to the match or not. Your decision now should be based only on your health. Don't go to the match and get sicker just because you already paid!

• Contribution Margin: This is a SUPER important concept! It is the money from sales that is left over to cover your fixed costs and then generate a profit.

  Contribution Margin per Unit = Selling Price per Unit - Variable Cost per Unit

  Example: Mama Biko's Chapati Palace

  Mama Biko sells one chapati for KES 20 (Selling Price).

  To make one chapati, she uses flour, oil, and charcoal. This costs her KES 12 (Variable Cost per unit).

  Let's calculate her contribution margin per chapati:

  Contribution Margin = KES 20 - KES 12 = KES 8

  This means for every chapati she sells, she gets KES 8 to help her pay her fixed costs (like the rent for her *kibanda*, which is KES 4,000 per month). After all fixed costs are paid, every extra KES 8 is pure profit! See how powerful that is?

> Image Suggestion: [A close-up, warm, and inviting photo of a person's hands skillfully preparing chapati on a floured surface. The lighting is soft and focuses on the chapati. In the background, you can see hints of a simple, clean kitchen or stall.]

Summary and Your Turn!

Wow, we have covered a lot! But look how far you've come. You now understand the language managers use to make businesses profitable and strong.

You've learned that:

• Costs can be Fixed, Variable, or Mixed depending on how they behave.
• Costs can be grouped into Product Costs (for making the item) and Period Costs (for running the business).
• Smart decisions involve thinking about Opportunity Costs and ignoring Sunk Costs.
• The Contribution Margin is key to understanding profitability.

Now, I have a challenge for you. The next time you buy a soda from your local *duka* or take a *matatu*, try to guess its costs. What are the variable costs? What are the fixed costs? This is how you start thinking like a top manager. Keep up the great work, and see you in the next lesson!