Every business in today’s world has one goal in mind; to increase their overall profit and drive their business into the future. So in order to achieve this goal, you will want to remember what types of expenses affect your business the most and how to effectively control costs in relation to your goals. To get started with us, first define fixed and variable costs.
Fixed costs are costs that are not directly related to the level of output or production. These are costs that, regardless of the amount of activity, remain the same and do not change. Some examples may include: income, depreciation, research and development, administrative/office salaries, advertising, office benefits, sales salaries, office supplies. Variable costs are costs that directly relate to products and change with output levels. Examples of various variables may include marketing, raw materials, sales commissions, wages for production workers, and utilities used in manufacturing. It is important to note that some costs can be changed to make their activity fixed or variable. For example, your sales salaries, which are commonly a fixed expense, can be changed to a variable cost by having the sales force work on commission for base pay.
Now that we have a basic understanding of what fixed and variable costs are, let’s look at what type of cost structure might be appropriate for your overall business needs. Now there are two types of free business structures most; fixed and variable.
Fixed cost structures operate solely with a focus on fixed costs associated with the company’s operations. This type of profit structure has infinite potential and infinite risks. In a completely fixed purchase structure, if your sales costs increase, they will remain the same, allowing your company to achieve higher profits. But if for any reason your company’s sales have decreased, your company can make a huge loss because the costs have to remain stable again. In general, a fixed purchase structure is very advantageous for companies that often experience an increase in their sales volume.
The world of variable cost structure puts its main focus on price uncertainty, which affects the business. There is little risk associate with a variable purchase structure, because sales costs rise with it and go with sales. costs go down In fact, the risk of this cost structure lies mainly with the suppliers, because if the business does not sell products, the supplier does not have a business. This price structure is predictive management because it allows the business to predict sales and costs more accurately then allows a fixed price structure. Overall, this cost structure is most beneficial to companies with declining sales volume.
As you can see, cost structures have their pros and cons. But before you make a final decision as to which purchasing structure is best for your company, I would like to discuss a few things about product cost analysis, which will give you a better understanding of which cost structure may be best for your business and for the future. need.
The product cost of the manufacturing plant includes all the direct (fixed) and indirect (variable) costs of producing the product, and these costs are treated as inventory. GAAP (Generally Accepted Accounting Principles) requires that all product costs (fixed or variable) be accrued in inventory until the inventory is sold. The costs of production are then expensed, as goods sold, by calculating the cost of goods purchased. This practice is known as absorption costing. Under full absorption costing, the only expenses that appear on the return of income are the cost of goods purchased. The results reported under this costing method may tempt management to produce more products than the company can sell, because certain overhead costs may be spread over or absorbed by several units. This will improve the gross profit margin and make the manufacturing process look more profitable. Be careful though; This type of management practice enables you to build in the inventory that you bring in. This can lead to extra costs (i.e. storage costs), risks (i.e. to selling more products for the company at one time), and reduce the total profit of the company in the long run. For this reason, companies will use what are known as various cost analysis tools for internal reporting purposes.
Variable cost analysis excludes fixed costs that do not increase management. Fixed costs are handled under your contribution margin cost and by using this free method you will see a higher improvement in your contribution margin. The reason is that this method does not try to produce you, it shows an improvement in production and decreases variable costs. This gives the company an advantage in maintaining long-term profitability.
GAAP requires companies to use absorption costing for financial reporting purposes, but does not rule out which method companies should use in reporting for internal purposes. So because of the pros and cons of both methods, many businesses use variable costing for internal reporting purposes, and use absorption for external reporting purposes.
With all that I said, I would like to recommend that if you are a small company that experiences variable costs, has a low volume of sales, and has a difficult time predicting market trends; then recommend that you use a consistent structure of various and varied analyzes for internal reporting purposes. Under a variable cost structure, you will be able to accurately predict your company’s profit at a given time and using various analysis to report internal objectives, you will not be tempted to produce.
On the other hand, if you are a company that sells several products at a given time and experiences a large volume of fixed costs, then I recommend using a fixed price structure and absorption rates for your reporting purposes. These methods will allow you to achieve higher profits and make your operations look more profitable, because your costs remain the same at your business level.
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