cost-analysis

No matter the specific example a manager must

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Unformatted text preview: level of business activity. No matter the specific example, a manager must understand their cost structure. 1.5 Economies of Sale Economists speak of the concept of economies of scale. This means that certain efficiencies are achieved as production levels rise. This can take many forms. For starters, fixed costs can be spread over larger production runs, and this causes a decrease in the per unit fixed cost. In addition, enhanced buying power results (e.g., quantity discounts) as volume goes up, and this can reduce the per unit variable cost. These are valid considerations. The accountant is not blind to these issues and must take them into consideration in any business evaluation. However, care must also be exercised to limit one’s analysis to a “relevant range” of activity. Below is an excerpt from an online catalog (Digi-Key Corporation). This is a pricing table for surface mount Zener Diodes. Notice that they are $0.44 each, or $3.00 for ten units, or $20.80 for 100 units, or $92.00 per thousand. The bottom line here is that they range from $0.44 down to $0.092 each, depending on the quantity purchased. This is quite a remarkable spread. Digi-Key Part Number Manufacturer Part Number * Description Quantity Available BZX84C36-FDICT-ND BZX84C36-7-F Diode Zener 300MW 36V SOT 23 2896 Price Break 1 10 100 250 500 1000 Unit Price 0.44000 0.30000 0.20800 0.15000 0.11200 0.09200 Price 0.44 3.00 20.80 37.50 56.00 92.00 Download free ebooks at bookboon.com 10 Cost Behavior Cost Analysis Please click the advert You’re full of energy and ideas. And that’s just what we are looking for. © UBS 2010. All rights reserved. Despite the wild spread in pricing, if your business needed about 150 of these diodes in your production process, you would study the above table and determine that the best quantity for you to order would be priced at $20.80 per hundred. As a result, your per unit variable cost would be $0.208. The “relevant range” is the anticipated activity level at which you will perform. Any pricing data outside of this range is irrelevant and need not be considered. This enhanced concept of variable cost is portrayed in the following graphic: Looking for a career where your ideas could really make a difference? UBS’s Graduate Programme and internships are a chance for you to experience for yourself what it’s like to be part of a global team that rewards your input and believes in succeeding together. Wherever you are in your academic career, make your future a part of ours by visiting www.ubs.com/graduates. www.ubs.com/graduates Download free ebooks at bookboon.com 11 Cost Behavior Cost Analysis The relevant range comes into play when considering fixed costs as well. Many fixed costs are only fixed for a certain level of production. For example, a machine or manufacturing plant can reach capacity. To increase production beyond a certain level, additional machinery (or a new plant, additional supervisors, etc.) must be deployed. This will cause a major step upward in the fixed cost. Fixed costs that behave in this fashion are also called step costs. These costs are illustrated by the following diagram. The key conceptual point is to note that fixed costs are only fixed over some particular range of activity, and moving outside that range can significantly alter the cost structure. 1.6 Dialing in Your Business Model After grasping the concepts of variable and fixed costs, it is important to understand their full implications in managing a business. Let’s first give added thought to fixed cost concepts. In an ideal setting, you would try to produce at the right-most edge of a fixed-cost step. This squeezes maximum productive output from a given level of expenditure. For a machine, it is as simple as running at full capacity. However, for a business with many fixed costs, it is more challenging to orchestrate operations so that each component is fully utilized. Some fixed costs are committed fixed costs arising from an organization’s commitment to engage in operations. These elements include such items as depreciation, rent, insurance, property taxes, and the like. These costs are not easily adjusted with changes in business activity. On the other hand, discretionary fixed costs originate from top management’s yearly spending decisions; proper planning can result in avoidance of these costs if cutbacks become necessary or desirable. Examples of discretionary fixed costs include advertising, employee training, and so forth. Committed fixed costs relate to the desired long-run positioning of the firm; whereas, discretionary fixed costs have a short-term orientation. Committed fixed costs are important because they cannot be avoided in lean times; discretionary fixed costs can be altered with proper planning. Of course, a company should be careful to avoid incurring excessive committed fixed costs. Download free ebooks at bookboon.com 12 Cost Behavior Cost Analysis Variable costs are also subject to adjustment. In the Digi-Key Corporation example, it was illustrated ho...
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This note was uploaded on 06/07/2013 for the course BA 201 taught by Professor Cuongvu during the Fall '13 term at RMIT Vietnam.

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