Business costs and expenses as expressed as a unit cost of a product can vary significantly as purchase or production volumes change. The first stage in using marginal costing to generate higher levels of profit is to identify the variability of all the individual cost elements.
Costs which are a component part of the product would normally be classified as variable costs since each component would require to be bought in specifically for that product. The cost of items bought for resale would also be classified as variable costs.
Fixed costs would be items not relating to the volume of goods manufactured or sold. Examples would be the premises costs, machinery costs.
A number of business expenses would be semi variable in that they can in some circumstances be viewed as a fixed expense but in other circumstances could also be viewed as variable expenses. Advertising expenses might be regarded as almost fixed expenses to promote the business or products whereas promoting the business name would be largely a fixed cost while specific product related advertising might be viewed as a variable product cost.
Wages and salaries are an important cost to most businesses and would normally be classified as semi variable. Administration salaries are more likely to be fixed while direct labour costs will contain both a fixed and variable element.
To operate a marginal costing program identify the variability of each cost item and evaluate that marginal cost and the fixed overheads of the business. To use the marginal costing as part of an accounting for profit program apply different volumes to the marginal costs.
At the lowest volume the fixed costs might well exceed the marginal profit, which in accounting terms is called the contribution, being the difference between the selling price and the marginal cost. The point at which the overall volume produces neither a loss nor a profit is called the break even point.
Break even analysis is important to ensure there is sufficient market demand to be able to exceed the break even point and the marketing effort will ensure that break even point is not just reached but easily achievable.
A further stage in accounting for profit would be to plan various volumes, the effect those volumes have on variable costs and occasionally on fixed costs too. Determine what is achievable and what is not achievable, the effect on the volume of profit and set business plans accordingly.
In addition to higher volumes producing higher marginal profits the variable costs also reduce when volumes increase and these changes require to be accounted for. Even if goods are being bought in purely for resale the variable costs will vary with volumes.
Buying in 100 items of a product will be cheaper than buying in 2 or 3. Selling and delivering the items individually is likely to cost more in distribution co0sts than selling in parcels of 10 or 20.
By analysing costs and their variability in relation to actual and potential volumes gives the accountant a real voice to influence management decisions in the way the business plans are constructed and by routine checks on progress using marginal costing as part of the budgeting and reporting process maximum profits can be achieved by accounting for profit.
Accounting techniques are flexible and able to be used in different situations. Despite popular belief, different factors are used in the same calculations depending on the situation. This manipulation aids the business owner in making informed decisions to manage operating expenses and other processes. Getting a clear definition of accounting profit will help in understanding the different options available to the bookkeeper and decision-makers.
Accounting profit is a fairly simple calculation, but it can easily be confused with so many other, similar, terms. The basic definition is the cost of providing products and services subtracted from the price of all those products and services sold. The area that gets hazy is exactly what costs are included in bringing items to the market. The 2 categories that costs are placed are explicit and implicit. Accounting profit is calculated using only explicit costs.
Explicit Costs are items or services that money is required to be paid for. When payment is spent directly for something it is considered an explicit cost. Every job will have different costs to account for, but some examples include wages for employees, raw materials, rent, fuel, and interest on loans.
When time is spent on one project or activity instead of another, which is implicit cost. It is also referred to as opportunity cost. Let's say an accountant chooses to repair his car himself instead of working in his office. If the repair takes 2 hours and the accountant could have been making $100/hr filing taxes then the implicit cost of repairing his car is $200.
Increasing the gap between price sold and price to produce can be done many ways. You can concentrate on lowering the cost by shopping around for lower prices, buying 1 item in bulk, or buying bundles of items from one seller and negotiating the price. One method that has been tried and failed is buying inferior supplies. The appearance of the product will look cheaper and it will not be as durable and if a customer is unsatisfied they will turn other customers away from you.
Another way to increase accounting profit is to increase the value or perceived value to raise the selling price. This can be done a multitude of ways, depending on the product or service. Higher quality material used, better construction methods, complimentary gifts and trinkets, delivery service, or even advertising with endorsements from respected celebrities.
As previously stated, accounting profit can be easily confused with other terms used to describe profit and revenue. When both explicit and implicit costs are added together, it equals total cost. When total income is subtracted by total cost, the outcome is defined as economic profit. As you can see the only difference between accounting profit and economic profit is the implicit or opportunity cost are figure in as well.
One way of remembering accounting profit is that accountant's generally calculate only the monetary costs needed to pay for operating expenses. This is the case with most profit calculations because a large number of times the opportunity costs vary or are undefined.
Article Source :
Joe Coffee has sinced written about articles on various topics from Marketing, Small Business. Joe Coffee is a consultant for the online marketing firm, Web Shepherd. Visit for tips about leading methods of accounting and small. Joe Coffee's top article generates over 18100 views. to your Favourites.