Conversion cost also known as cost per conversion for a certain marketing channel is an important indicator of how well a company is performing on various marketing channels.
The Cost per Conversion metric can help show the ROI for an online marketing campaign, where the goal is to convert visitors into paying customers.
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Hire An Expert Tutor NowConversion costs = direct labor + manufacturing overhead costs
This concept is important to accounting and helps a business determine its true costs when producing a product. If you experience some difficulty in understanding this concept, let an online accounting homework help service relieve you of your stress. Ask us to help you solve your accounting homework problems.
What Does Conversion Cost Consist of;
Conversion cost consists of;
- Direct labor benefits that includes training, consulting, sales operations, customer service, and other labor costs.
- Factory Rent
- Factory insurance
- Production utilities
- Production supervision
- Unassembled parts
- Production equipment
Importance of conversion cost
Fund accounting students learn about Conversion Cost in their second year, and subsequently, learn how to calculate it.
Many students struggle with the metric when they first see it, but once you understand how to calculate it, it is one of the best metrics to determine whether or not your product or service is making a profit. It’s important that you also learn the importance of fund accounting. Below are some of its advantages:
1. Identify Waste and Evaluate how Effectively the Production Process Works
The cost per conversion for each marketing channel is an important indicator of how well the company is doing on each channel. Some channels are more expensive than others and will naturally incur more direct labor and factory overhead costs, which make them more costly.
The best way to reduce waste through improved efficiency is to improve the process knowledge of the production department; so they can purchase components in bulk, order parts at the right time, and estimate the number of materials needed to produce a product based on past productions run and other processes improvements to save time and money.
2. Understand the Cost of Marketing Channels
There are three main factors that will determine how much money a company spends to get a customer: The conversion cost per marketing channel, the product look and feel, and the product marketing spend.
The conversion cost per marketing channel is how much money it costs to get one customer from acquisition to paid customer.
The Cost per conversion metric will help identify which factors have the highest impact on customer acquisition costs. That way you can spend more time researching how to reduce costs in these areas and increase profit per customer.
Advantages of Conversion
The advantages include:
1. Provide You with Social Support
Conversion cost gives you an operational picture of how well your different marketing channels are doing. It helps you see which marketing strategies have higher conversion costs. You can use this information to improve the way you choose the best marketing strategies for your business.
2. Identify Your Key Values
Conversion cost is a KPI that allows you to see what is happening internally, in the company, and externally, in the market, in order to make decisions about your overall strategy. You can compare different strategies and decide which is best for your company.
3. Provide You with the Information to Improve Process Efficiency
Conversion cost, for a certain marketing channel, will give you an idea of how efficiently the production process is working. That way you can discover the best ways to improve this process to reduce costs and increase profit per customer acquired.
Disadvantages of conversion cost
The disadvantages include;
1. Too Much Focus on the Product or Channel
It is important to focus on the most important things, giving you more time and energy to develop your company further. But it is also important to keep an eye on the different costs involved in marketing activities. If you don’t see some growth in the process, it’s time for you to evaluate which marketing activities are not working so well.
2. Impossible to Compare Costs of Different Marketing Strategies
You don’t want to calculate the conversion cost that has more marketing strategies than other channels. For example, if you have a Facebook page, an Instagram account, and a Twitter profile, it is impossible to calculate the conversion cost for each one. You can compare them in general but it is not possible to determine which marketing strategy has the highest conversion rate or the lowest cost per customer.
Conversion Cost vs Prime Cost
Prime cost – is the sum of conversion cost and general administrative expenses. For example, in a company with 5 marketing channels: TV, Radio, Facebook, Twitter, and Instagram. The Prime Cost would be the sum of all marketing expenses plus other general administrative costs for that company.
Advantages of prime cost
- It gives you an operational picture of how your different business units are doing.
Disadvantages of Prime Cost
- It is not possible to compare Prime Cost from different companies.
All in all, Conversion cost is a metric that gives you an idea of how efficient the company is in attracting customers. It allows you to see which marketing strategies work better in certain situations based on your business goals and allows you to evaluate the efficiency of your production process.
What is a good cost per conversion?
Depending on your sector, your good or service, and the kind of advertising campaign you’re doing, you will see different kinds of conversion rates.
Example 1
Below is the information to calculate conversion cost and the conversion cost per unit:
- Completed Units = 40,000
- Direct Wages = $32,000
- Indirect Wages = $3,500
- Direct Material = $26,000
- Indirect Material = $750
- Equipment Depreciation = $5,500
- Office Expenses = $6,000
- Fcatory Insurance = $1,500
Assumption; there was no work in process inventory at the beginning and at the end of the accounting period.
Solution
Conversion Cost = Direct Labor + Manufacturing Overheads
Direct Labor = $32,000
Manufacturing Overheads = Indirect Wages + Indirect Material + Equipment Depreciation + Factory Insurance
= $3,500 + $750 + $5,500 + $1,500
= $11,250
Conversion Cost = $32,000 + $11,250
Conversion Cost = $43,250
Conversion Cost per unit = Conversion Cost / Completed Units
Conversion Cost per unit = $43,250 / 40,000
Conversion Cost per unit = $1.08
Example 2
During a month, Bisma Company has a total cost of $60,000 in direct labor and $68,000 in factory overhead costs. Bisma Company produced 26,000 units during the month.
Solution
Conversion Cost = Direct Labor + Manufacturing Overheads
Conversion cost = $60,000+$68,000
Conversion Cost = $128,000
Conversion Cost per unit = Conversion Cost / Completed Units
Conversion cost per unit = $128,000/26,000
Conversion Cost per unit = $4.92 per unit.
As you can see conversion cost can give you a sense of how well your company is working as a customer acquisition department. It will allow you to discover the GAAP and the best practices in customer acquisition that will improve the way your company works from day to day. It will also help you calculate your marketing costs and will provide you with information on which marketing channels to invest in for the future.
Additional Resources
This has been CFI’s guide to Conversion Cost. To advance your career as an analyst, read more about the other elements that populate financial statements:
