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1. Marginal costing
2. Marginal cost
o Break-even analysis
o Margin of safety
14.Profit planning
MARGINAL COST
In economics and finance, marginal cost is the change in total cost
that arises when the quantity produced changes by one unit. It is
the cost of producing one more unit of a good.[1] Mathematically, the
marginal cost (MC) function is expressed as the first derivative of
the total cost (TC) function with respect to quantity (Q). Note that
the marginal cost may change with volume, and so at each level of
production, the marginal cost is the cost of the next unit produced.
Externalities
Externalities are costs (or benefits) that are not borne by the parties
to the economic transaction. A producer may, for example, pollute
the environment, and others may bear those costs. A consumer may
consume a good which produces benefits for society, such as
education; because the individual does not receive all of the
benefits, he may consume less than efficiency would suggest.
Alternatively, an individual may be a smoker or alcoholic and
impose costs on others. In these cases, production or consumption
of the good in question may differ from the optimum level.
[edit] Negative externalities of production
Much of the time, private and social costs do not diverge from one
another, but at times social costs may be either greater or less than
private costs. When marginal social costs of production are greater
than that of the private cost function, we see the occurrence of a
negative externality of production. Productive processes that result
in pollution are a textbook example of production that creates
negative externalities.
When marginal social costs of production are less than that of the
private cost function, we see the occurrence of a positive externality
of production. Production of public goods are a textbook example of
production that create positive externalities. An example of such a
public good, which creates a divergence in social and private costs,
includes the production of education. It is often seen that education
is a positive for any whole society, as well as a positive for those
directly involved in the market.
Social costs
• Fixed costs are costs which do not vary with output, for
example, rent. In the long run all costs can be considered
variable.
• Variable cost also known as, operating costs, prime costs, on
costs and direct costs, are costs which vary directly with the
level of output, for example, labour, fuel, power and cost of
raw material.
• Social costs of production are costs incurred by society, as
a whole, resulting from private production.
• Average total cost is the total cost divided by the quantity
of output.
• Average fixed cost is the fixed cost divided by the quantity
of output.
• Average variable cost are variable costs divided by the
quantity of output.
Salient Points:
• All operating costs are differentiated into fixed and variable costs;
• Fixed cost treated as period cost and written off to the profit and loss
account
Disadvantages Of Marginal Costing
• It’s not a good costing technique in the long run for pricing
decision as it ignores fixed cost. In the long run, management
must consider the total costs not only the variable portion;
Elements of a decision
The costs which should be used for decision making are often
referred to as "relevant costs". CIMA defines relevant costs as 'costs
appropriate to aiding the making of specific management decisions'.
Other terms:
e) Sunk costs: Another name for past costs, which are always
irrelevant, e.g. dedicated fixed assets, development costs already
incurred.
Opportunity cost
Example
The relevant costs for decision purposes will be the sum of:
i) 'avoidable outlay costs', i.e. those costs which will be incurred only
if the book project is approved, and will be avoided if it is not
ii) the opportunity cost of the leather (not represented by any outlay
cost in connection to the project).
b) The amount of fixed costs, unit variable costs, sales price and
sales demand are known with certainty.
Formula :
Sales
Significance of PV Ratio
• The higher the PV Ratio, the better it is for the business. In the
case of the firm enjoying steady business conditions over a
period of years, the PV Ratio will also remain stable and
steady.
Improvement of PV Ratio
Use of PV Ratio
Total cost = total fixed cost + (variable cost per unit number
of units)
Y = a + bx
b) Also, total costs will fall by the variable cost per unit for
each reduction by one unit in the level of activity.
MARGIN OF SAFETY
Margin of safety represents the strength of the business. It enables
a business to know that what is the exact amount he/ she has
gained or loss over or below break even point).
In unit sales
Firms may still decide not to sell low-profit products, for example
those not fitting well into their sales mix. Firms may also sell
products that lose money - as a loss leader, to offer a complete line
of products, etc. But if a product does not break even, or a potential
product looks like it clearly will not sell better than the breakeven
point, then the firm will not sell, or will stop selling, that product.
An example:
Significance:
Examples are:
• -bank balances
• -outgoing checks posted to the bank clearing account
• -outgoing transfers posted to the bank clearing account
• -maturing deposits and loans
• -notified incoming payments posted to the bank account
• -incoming payments with a value date
•
The Cash position and forecast is all about amounts and dates. The
section explains how the dates are determined for the various
inputs.
Understanding how a Profit and Loss Account works will help you to
choose the right time to buy items that you need for the business,
reduce your tax liability (Tax Bill) and work out how much Tax you
will have to pay.
Given the central role profit planning can play in the future
prospects of an organization, it might come as a surprise to learn
that a large number of businesses do not usually have or develop a
financial plan. What is even more amazing is that many of the
businesses which do plan for their financial future often just repeat
the same procedure over and over every year. They do not take the
time to look at how the plan works, or if it is really working.
Effective profit planning can have a deep impact in the life of your
organization. The professionals at FRS Consultants believe that
profit planning is a key element which has led to the success of big
and small businesses alike. That said, it could truly ensure
continuous prosperity for your own business, as well. FRS
Consultants is a trustworthy firm of honest and experienced
professionals that can lead you to make the best out of profit
planning. Many goldbricks in the field are more eager to charge you
premiums for their time than to deliver what you are paying for. At
FRS Consultants we do not shirk our work. We will strive to deliver
on time and prove the value of our service. Other consulting firms
may seem less expensive than us, but that is not the case. To learn
more or to request a free consultation please complete our online
form.