Cost-Per-Test: Exploring the What and Why
November 28, 2023Cost-per-Test: Activities are the key
December 12, 2023Cost-per-test: Decoding the different calculation methods
The basics of a cost-per-test calculation were discussed in the previous post, describing what the metric includes and why it is significant for a laboratory to be able to calculate a concise, predictably repeatable, and easily interrogated cost-per-test.
This post will investigate various methods found online. While the list might not be exhaustive, the exercise will highlight the key factors to consider when choosing a method that works for you.
Cost-per-test Methods
For each method, we will look at the basic calculations, the benefits you can expect, and the possible drawbacks in implementation and application. Please note that you need to find the method that works for you and your organization while being mindfull of the importance of a transparent calculation for all stakeholders to understand.
Direct Costing
As the name suggests, this method considers only the direct costs linked to a test, such as reagents, consumables, equipment maintenance, and direct labor.
Benefits: This method is straightforward and provides a quick overview of the direct and most variable costs.
Drawbacks: The calculated cost-per-test does not provide the entire picture becuse you only used direct costs. For laboratory tests, indirect costs will most likely overshadow the direct costs in both number and value. A direct-cost-per-test does not, in my opinion, provide meaningful insights for long-term strategic decisions.
Marginal Costing
Like the direct costing method, marginal costing only includes costs that increases along with the test volumes. So, again, only direct costs are included, but costs like equipment maintenance are not, as this is direct yet fixed cost.
Benefits: It is a handy, practical short-term decision-making calculation as it emphasizes the variable cost.
Drawbacks: By ignoring fixed costs, which can become substantial over a long period, this method can lead to skewed decision making. For instance, instrument capacities are also not considered.
Full Costing
The full-costing method includes direct and indirect costs by summing up all costs and dividing them by the total number of tests. In this way you can obtain the full cost-per-test.
Benefits: This method offers a more comprehensive understanding than the direct costing-method by including all costs. It also consists of a straightforward, easy-to-understand calculation.
Drawbacks: Using the number of tests as the method for the distribution of costs might not accurately reflect a fair allocation of burden of the test.
Standard Costing
A standard cost-per-test is calculated based on historical data, industry standards, or internal expectations. Pre-determined hours are multiplied by a predetermined cost rate, calculating the staff cost, which can then be compared against actual costs.
Benefits: This method facilitates performance evaluations and cost control through variance analysis.
Drawbacks: The setup and the subsequently required maintenance of the standards might become a challenge due to its resource-intensive nature. The standard cost might be based on unrealistic internal expectations or the application of unfair standards.
Cost-Volume-Profit Analysis
This analysis examines the relationship between costs, the volume of tests, and revenue. It considers test price, variable costs per test, fixed costs, and the break-even point. By analyzing the cost-volume-profit relationship, you can estimate the cost per test at different numbers of tests performed.
Benefits: This method aids profit planning, sensitivity analysis, break-even identification, informed decision-making, and efficient resource allocation.
Drawbacks: Cost-volume-profit analysis assumes a linear correlation between changes in cost and revenue, and changes in activity levels or volumes. It is also a very static analysis, not including, for instance, efficiency improvements or technology changes, etc. With a limited scope and single-dimensional focus on the relationship between costs, volume, and profit, it is better suited for short-term decision-making.
Activity-Based Costing (ABC)
Activity-Based Costing (ABC) enhances cost-per-test accuracy in laboratories. By breaking processes into activities, ABC can precisely allocate costs. This method provides a nuanced understanding of each test's cost drivers, facilitating informed decision-making and resource optimization in a diverse and dynamic laboratory environment.
Benefits: This method can provide a detailed breakdown and representation of costs, as well as a more nuanced understanding of cost drivers and the activities they are associated with.
Drawbacks: The implementation of ABC can be resource- and time-intensive. The inherent complexity of laboratory operations, the number of unique tests and procedures, and the vast number of distinct activities and costs will make standard ABC arduous to implement and maintain.
Conclusion
So, there are many ways to approach the cost-per-test calculation. Unfortunately, there is no method that clearly stands out above the others, with each having benefits and drawbacks. You might prefer increased detail and accuracy, but you will pay in implementation time, or you might like the quick and cost-effective approach but pay in unreliable long-term information or insight.
Choosing the most suitable method depends on the specific need of your laboratory, the resources available, and the level of detail required for your decision-making.
