Definition from 12th Bus. Reader
According to fayol,"People and materials must be in suitable places at appropriate time for maximum efficiency."The principle of order states that " A place for evrything (everyone) and everything(everyone) in its (his/her) place',Essentially it means orderliness.If there is a fixed place for everything and its present there, then there wil be no hindrance in the activities of business/factory. This will lead to increased efficicency.
Material order is,specific place for each material and must be in its alloted place. Social order is, each employee should be assigned right place for work.
Definition from a Website
According to Fayol there should be proper, systematic and orderly arrangement of physical and social factors, such as land, raw materials, tools and equipments and employees respectively. As per view, there should be safe, appropriate and specific place for every article and every place to be used effectively for a particular activity and commodity. In other words, principles that every piece of land and every article should be used properly, economically and in the best possible way. Selection and appointment of the most suitable person to every job. There should be specific place for every one and every one should have specific place. This principle also stresses scientific selection and appointment of employees on every job.
Wednesday, 27 January 2010
Tuesday, 26 January 2010
Friday, 22 January 2010
Management Development Programme - Sabina
“Development is an effort that enhances the learner’s capacity to manage.”
Management Development Programme is a series of classes, seminars and exercises’ to teach and develop the skills necessary to become good manager. These skills include planning, evaluating, motivating, reporting goal settings.
It develops program to increase managerial effectiveness.
Management Development Programme is a series of classes, seminars and exercises’ to teach and develop the skills necessary to become good manager. These skills include planning, evaluating, motivating, reporting goal settings.
It develops program to increase managerial effectiveness.
PERT and CPM - by Saba (Mr.Ayesha)
PERT & CPM are techniques of project management, useful in the basic managerial function of planning, scheduling and controlling
PERT stands for “programme evaluation & review technique” whereas CPM is abbreviation of “critical path method”
If the project undertaken by project business houses are very large and take a number of years before commercial production starts, the techniques of PERT and CPM help greatly in completing the various jobs in the schedule. They minimize production delays, interruption and conflicts
PERT is sophisticated tool used in planning , scheduling and controlling large projects consisting of a number of activities independent of one another and with uncertain completion times. Following steps are required for using CPM and PERT for planning and scheduling
1. Each project consists of several independent jobs or activities. All these jobs or activities must be separately listed
2. Once the list of various activities is ready the order of precedence of the job has to be determined
3. The next step is to draw a picture or a graph which portrays each of these jobs and shows the predecessor and successor relation among them
Now the project of budgeting can be shown by way of a project graph network
1. Arrow connecting numbers 1 and 2 represent a job i.e. forecasting unit sales which would take 14 days
2. Numbers 2 and 4 represent job ‘b’ which will take 10 days and so on
3. It is seen that job ‘c’ is not dependent upon job b and therefore , the two jobs can be done simultaneously
Once we reduce the project to network of activities and events and we estimate activity duration, we are in position to determine the minimum time required for completion of whole project.
To do so we must find the longest path or sequence connecting the activities through the network. This is called “critical path” the longest path is the “critical path of the project”.
In our example there our two paths
One is connecting 1, 2, 4, &5 this will take 14+10+10= 34 days
The other path is connecting numbers 1,2,3,4 & 5; this path will take 14+7+4+10 = 35 days.
Obviously, the second path is the critical path and the project of budget presentation will take this much of time
Note: this time is shorter than the total time tested in under table 1 which will be 45 days. This is because job ‘b’ and ‘c’ can be done simultaneously
A good project network goes a long way in reducing cost.
PERT stands for “programme evaluation & review technique” whereas CPM is abbreviation of “critical path method”
If the project undertaken by project business houses are very large and take a number of years before commercial production starts, the techniques of PERT and CPM help greatly in completing the various jobs in the schedule. They minimize production delays, interruption and conflicts
PERT is sophisticated tool used in planning , scheduling and controlling large projects consisting of a number of activities independent of one another and with uncertain completion times. Following steps are required for using CPM and PERT for planning and scheduling
1. Each project consists of several independent jobs or activities. All these jobs or activities must be separately listed
2. Once the list of various activities is ready the order of precedence of the job has to be determined
3. The next step is to draw a picture or a graph which portrays each of these jobs and shows the predecessor and successor relation among them
Now the project of budgeting can be shown by way of a project graph network
1. Arrow connecting numbers 1 and 2 represent a job i.e. forecasting unit sales which would take 14 days
2. Numbers 2 and 4 represent job ‘b’ which will take 10 days and so on
3. It is seen that job ‘c’ is not dependent upon job b and therefore , the two jobs can be done simultaneously
Once we reduce the project to network of activities and events and we estimate activity duration, we are in position to determine the minimum time required for completion of whole project.
To do so we must find the longest path or sequence connecting the activities through the network. This is called “critical path” the longest path is the “critical path of the project”.
In our example there our two paths
One is connecting 1, 2, 4, &5 this will take 14+10+10= 34 days
The other path is connecting numbers 1,2,3,4 & 5; this path will take 14+7+4+10 = 35 days.
Obviously, the second path is the critical path and the project of budget presentation will take this much of time
Note: this time is shorter than the total time tested in under table 1 which will be 45 days. This is because job ‘b’ and ‘c’ can be done simultaneously
A good project network goes a long way in reducing cost.
Wednesday, 20 January 2010
Span of Control - by Razia
(sometimes called span of management) refers to the number of workers who report to one manager. For hundreds of years, theorists have searched for an ideal span of control. When no perfect number of subordinates for a manager to supervise became apparent, they turned their attention to the more general issue of whether the span should be wide or narrow. A wide span of management exists when a manager has a large number of subordinates.
Generally, the span of control may be wide when:
(i) The manager and the subordinates are very competent.
(ii) The organization has a well-established set of standard operating procedures.
(iii) Few new problems are anticipated.
(iv) A narrow span of management exists when the manager has only a few subordinates.
The span should be narrow when:
(i) Workers are located far from one another physically.
(ii) The manager has a lot of work to do in addition to supervising workers.
(iii) A great deal of interaction is required between supervisor and workers.
(iv) New problems arise frequently.
(v) Keep in mind that the span of management may change from one department to another within the same organization.
(iv) Capacity of subordinates: If the subordinates are skilled, efficient and knowledgeable, they will require less supervision. In such a case, the superior may go in for a wider span.
(v) Effectiveness of communication: If there is an effective communication system in the organization, it favours large number of levels because there will be no difficulty in transmission of information in spite of a large number of intervening layers.
(vi) Control devices: The span of control also depends upon the control practices being followed.
(vii) Organisational assistance available to the manager: Staff functions such as training, recruiting and quality control free the managers from frustrating routine work and permit them to increase their span.
(viii) Degree of supervisory co-ordination needed: The lesser co-ordination needed, the broader the span. Similarly the lesser the planning required, the larger the span. Activities like launching a new product, surviving in a highly competitive environment demand careful planning whereas activities like filing, indexing, dispatching require little planning.
(ix) Geographic proximity: The closer a work group is located physically, the larger the span.
(x) Similarity of functions: The more similar the functions performed by the work group, the larger the span.
Generally, the span of control may be wide when:
(i) The manager and the subordinates are very competent.
(ii) The organization has a well-established set of standard operating procedures.
(iii) Few new problems are anticipated.
(iv) A narrow span of management exists when the manager has only a few subordinates.
The span should be narrow when:
(i) Workers are located far from one another physically.
(ii) The manager has a lot of work to do in addition to supervising workers.
(iii) A great deal of interaction is required between supervisor and workers.
(iv) New problems arise frequently.
(v) Keep in mind that the span of management may change from one department to another within the same organization.
(iv) Capacity of subordinates: If the subordinates are skilled, efficient and knowledgeable, they will require less supervision. In such a case, the superior may go in for a wider span.
(v) Effectiveness of communication: If there is an effective communication system in the organization, it favours large number of levels because there will be no difficulty in transmission of information in spite of a large number of intervening layers.
(vi) Control devices: The span of control also depends upon the control practices being followed.
(vii) Organisational assistance available to the manager: Staff functions such as training, recruiting and quality control free the managers from frustrating routine work and permit them to increase their span.
(viii) Degree of supervisory co-ordination needed: The lesser co-ordination needed, the broader the span. Similarly the lesser the planning required, the larger the span. Activities like launching a new product, surviving in a highly competitive environment demand careful planning whereas activities like filing, indexing, dispatching require little planning.
(ix) Geographic proximity: The closer a work group is located physically, the larger the span.
(x) Similarity of functions: The more similar the functions performed by the work group, the larger the span.
Long Range Planning - by Razia
Long Range planning is the process of establishing long-term goals, working out strategies, policies and programmes to achieve these goals. In other words, long range planning sets long-term goals for the enterprise and formulates strategic plans for attaining these goals. It involves an attempt to anticipate, analyse and make decisions about basic problems which have significant effects well beyond the present operating horizon of the enterprise. Long range planning is done by the top management.
Long range planning generally covers a period ranging from 5 years to 20 years or even more. The period will vary from organisation to organisation. It may be five years for a departmental store and at least twenty-five years for a company intending to take up the production of timber. The purpose of long range planning may include technological leadership, increase in market share, globalisation of production and marketing, public image, etc.
Long range planning may involve capital budgeting, product planning,
project planning, acquisition of competing units. It may involve a complete change in outlook of the business. It deals with the broad technological,
financial and competitive aspects of the business. Because of this, long range planning is associated with a great deal of uncertainty. Its success will be determined by the ability of the organisation to predict and deal with the environment.
Long range planning generally covers a period ranging from 5 years to 20 years or even more. The period will vary from organisation to organisation. It may be five years for a departmental store and at least twenty-five years for a company intending to take up the production of timber. The purpose of long range planning may include technological leadership, increase in market share, globalisation of production and marketing, public image, etc.
Long range planning may involve capital budgeting, product planning,
project planning, acquisition of competing units. It may involve a complete change in outlook of the business. It deals with the broad technological,
financial and competitive aspects of the business. Because of this, long range planning is associated with a great deal of uncertainty. Its success will be determined by the ability of the organisation to predict and deal with the environment.
Tuesday, 19 January 2010
Chain of Command - By Razia
Definition
==========
Order in which authority and power in an organization is wielded and delegated from top management to every employee at every level of the organization. Instructions flow downward along the chain of command and accountability flows upward. According to its proponent Henri Fayol, the more clear cut this chain the more effective the decision making process and greater the efficiency. Military is an example of straight chain of command which extends in unbroken line from the top brass to ranks. Also called line of command.
Chain of Command
================
An organizational structure in which authority passes down from the top and each person in the chain is directly responsible to the persn above.
In a military context, the chain of command is the line of authority and responsibility along which orders are passed within a military unit and between different units. Orders are transmitted down the chain of command, from a higher-ranked soldier, such as a commissioned officer, to lower-ranked personnel who either execute the order personally or transmit it down the chain as appropriate, until it is received by those expected to execute it.
In general, military personnel give orders only to those directly below them in the chain of command and receive orders only from those directly above them. A service member who has difficulty executing a duty or order and appeals for relief directly to an officer above his immediate commander in the chain of command is likely to be disciplined for not observing the chain of command.
The concept of chain of command also implies that higher rank alone does not entitle a higher-ranking service member to give commands to anyone of lower rank. For example, an officer of unit "A" does not directly command lower-ranking members of unit "B", and is generally expected to approach an officer of unit "B" if he requires action by members of that unit. The chain of command means that individual members take orders from only one superior and only give orders to a defined group of people immediately below them.
In addition, within combat units, line officers are in the chain of command, but officers in specialist fields (such as medical, dental, legal, supply and chaplain) are not, except within their own specialty. For example, a medical officer in an infantry battalion would be responsible for the combat medics in that unit, but would not be eligible to command the battalion or any of its subordinate units.
The term is also used in a civilian management context describing comparable hierarchical structures of authority.
==========
Order in which authority and power in an organization is wielded and delegated from top management to every employee at every level of the organization. Instructions flow downward along the chain of command and accountability flows upward. According to its proponent Henri Fayol, the more clear cut this chain the more effective the decision making process and greater the efficiency. Military is an example of straight chain of command which extends in unbroken line from the top brass to ranks. Also called line of command.
Chain of Command
================
An organizational structure in which authority passes down from the top and each person in the chain is directly responsible to the persn above.
In a military context, the chain of command is the line of authority and responsibility along which orders are passed within a military unit and between different units. Orders are transmitted down the chain of command, from a higher-ranked soldier, such as a commissioned officer, to lower-ranked personnel who either execute the order personally or transmit it down the chain as appropriate, until it is received by those expected to execute it.
In general, military personnel give orders only to those directly below them in the chain of command and receive orders only from those directly above them. A service member who has difficulty executing a duty or order and appeals for relief directly to an officer above his immediate commander in the chain of command is likely to be disciplined for not observing the chain of command.
The concept of chain of command also implies that higher rank alone does not entitle a higher-ranking service member to give commands to anyone of lower rank. For example, an officer of unit "A" does not directly command lower-ranking members of unit "B", and is generally expected to approach an officer of unit "B" if he requires action by members of that unit. The chain of command means that individual members take orders from only one superior and only give orders to a defined group of people immediately below them.
In addition, within combat units, line officers are in the chain of command, but officers in specialist fields (such as medical, dental, legal, supply and chaplain) are not, except within their own specialty. For example, a medical officer in an infantry battalion would be responsible for the combat medics in that unit, but would not be eligible to command the battalion or any of its subordinate units.
The term is also used in a civilian management context describing comparable hierarchical structures of authority.
ACCOUNT TREATMENT OF GOODWILL ON ADMISSION OF PARTNERS
At the time of an admission belongs entirely to the existing partners who have created it. There are three ways of valuing goodwill on admission of partners as follows: -
Method No.1 :
==========
Goodwill is recorded in FULL in the books of accounts
-------------------------------------------------------------------
- A goodwill account is opened and the amount of goodwill is debited to this account.
- Existing/Old Partners Capital Accounts are credited in the proportion of their old profit sharing ratio
Account Entries:
--------------------
Debit : Goodwill Account
Credit : Old Partner?s Capital Accounts in old profit sharing ratio
Method No.2 :
==========
Scenario No. 1 : Where Goodwill is NOT recorded in the books of accounts
--------------------------------------------------------------------------------------------
- Goodwill is not recorded in the books hence NO goodwill account is open
- Incoming partner pay his proportion of the agreed value of goodwill in CASH.
- Additional cash brought in by new partner is known as premium and is credited to the Capital Accounts of the existing partners in their old profit sharing ratio
Account Entries:
--------------------
Debit : Cash Account (Total Cash brought in by the new partners)
Credit : New Partner?s Account (Capital introduced)
Credit : Existing / Old Partners (Premium of Goodwill)
Scenario No. 2 : Where Goodwill is Opened and the written off from the books of accounts
---------------------------------------------------------------------------------------------------
- There is a more tedious way of doing it.
- You need to open goodwill account in the books and then write off using the new profit sharing ratio
- Using this method you still get back the result as scenario one where goodwill is never open / created in the books
Account Entries:
--------------------
Debit : Goodwill Account with total value of goodwill
Credit : Old / Existing Partner?s Capital Account with goodwill in old profit sharing ratio
Method No.3 :
==========
Goodwill is NOT recorded in the books and paid DIRECT to the existing /old partners
---------------------------------------------------------------------------------------------------
- No record in the partnership?s books
- Least advantageous to incoming partners as the money which he pays for goodwill is not kept in the business
Method No.1 :
==========
Goodwill is recorded in FULL in the books of accounts
-------------------------------------------------------------------
- A goodwill account is opened and the amount of goodwill is debited to this account.
- Existing/Old Partners Capital Accounts are credited in the proportion of their old profit sharing ratio
Account Entries:
--------------------
Debit : Goodwill Account
Credit : Old Partner?s Capital Accounts in old profit sharing ratio
Method No.2 :
==========
Scenario No. 1 : Where Goodwill is NOT recorded in the books of accounts
--------------------------------------------------------------------------------------------
- Goodwill is not recorded in the books hence NO goodwill account is open
- Incoming partner pay his proportion of the agreed value of goodwill in CASH.
- Additional cash brought in by new partner is known as premium and is credited to the Capital Accounts of the existing partners in their old profit sharing ratio
Account Entries:
--------------------
Debit : Cash Account (Total Cash brought in by the new partners)
Credit : New Partner?s Account (Capital introduced)
Credit : Existing / Old Partners (Premium of Goodwill)
Scenario No. 2 : Where Goodwill is Opened and the written off from the books of accounts
---------------------------------------------------------------------------------------------------
- There is a more tedious way of doing it.
- You need to open goodwill account in the books and then write off using the new profit sharing ratio
- Using this method you still get back the result as scenario one where goodwill is never open / created in the books
Account Entries:
--------------------
Debit : Goodwill Account with total value of goodwill
Credit : Old / Existing Partner?s Capital Account with goodwill in old profit sharing ratio
Method No.3 :
==========
Goodwill is NOT recorded in the books and paid DIRECT to the existing /old partners
---------------------------------------------------------------------------------------------------
- No record in the partnership?s books
- Least advantageous to incoming partners as the money which he pays for goodwill is not kept in the business
PARTNERSHIP
CHARATERISTICS OF PARTNERSHIP
===========================
1. Partnership is not legal entity and partners can only be sued;
2. The liability of each partner is unlimited;
3. A partnership must comprise of at least two members. The maximum number allowed is twenty;
4. Partnerships are governed by the relevant Partnership Act. If the partners do not make their own agreement, or if their own agreement does not cover any particular matter specified in the Partnership Act, provisions of the Partnership Act dealing with that particular matter will become applicable.
ADVANTAGES OF PARTNERSHIP
========================
1. Like the sole proprietorship, disclosures of financial statements to the general public are not required;
2. Easy to form compared to a limited company;
3. Higher capital is available compared to a sole proprietorship;
4. Taking advantage of the different expertise and skill of the different partners;
5. Low cost of formation;
6. Tax advantage;
7. Partnerships not subjected to many regulations compared to limited companies.
DISADVANTAGES OF PARTNERSHIP
===========================
1. Lack of flexibility unlike the one-man show of a sole proprietorship;
2. Still cannot avoid the unlimited liability like the sole proprietorship;
3. Limited life when one of the partners withdraws or dies, then the partnership will dissolve by itself;
4. Conflicts amongst the partners might affect the stability of the partnership;
5. Capital though higher than a sole proprietorship but still limited compared to a limited company.
SALIENT POINTS TO NOTE:
=====================
The general practice is to have some form of agreement between the partners setting out their rights, duties and liabilities. This agreement is referred as the Partnership Deed.
The normal clauses in a Partnership Deed includes the following:
• Names of the partners and firm’s name;
• Nature of the business;
• Term of the partnership;
• Capital to be introduced by each partner;
• Profit and loss sharing ratios;
• Arrangements as to partners’ drawings and salaries;
• Arrangements regarding interest on capital, advances and drawings;
• Provisions regarding the retirement or death of a partner;
• Method of valuing goodwill upon retirement or death of a partner and
• Other details to be observed by partners.
MAJOR DIFFERENCES OF THE FINANCIAL STATEMENT OF A SOLE PROPRIETORSHIP AND PARTNERSHIP:
==================================================
Capital Account : In Sole Proprietorship (SP) only one capital account is prepared. In Partnership (PS) more than one capital account is prepared. The number of capital account in PS depends on the number of partners in the Partnership concern.
Profit / Loss : In SP all the profit belongs to the owner whereas in PS, profit and loss distributed to the partners’ capital account according to the agreed ratio.
Income Statement : No income statement is prepared in SP. The Income statement of the partnership shows a schedule on how the net profit/loss is distributed to the partners.
Balance Sheet : In SP, balance sheet shows only one capital account which belongs to the single owner. In PS, balance sheet shows the balance of the capital amount of each partner classified under owner’s equity.
Statement of Partner’s Equity : In SP, no such statement is prepared. In PS, besides the income statement and balance sheet, a Statement of partner’s equity is also prepared to show the changes in equity of each partner since the beginning of the year.
===========================
1. Partnership is not legal entity and partners can only be sued;
2. The liability of each partner is unlimited;
3. A partnership must comprise of at least two members. The maximum number allowed is twenty;
4. Partnerships are governed by the relevant Partnership Act. If the partners do not make their own agreement, or if their own agreement does not cover any particular matter specified in the Partnership Act, provisions of the Partnership Act dealing with that particular matter will become applicable.
ADVANTAGES OF PARTNERSHIP
========================
1. Like the sole proprietorship, disclosures of financial statements to the general public are not required;
2. Easy to form compared to a limited company;
3. Higher capital is available compared to a sole proprietorship;
4. Taking advantage of the different expertise and skill of the different partners;
5. Low cost of formation;
6. Tax advantage;
7. Partnerships not subjected to many regulations compared to limited companies.
DISADVANTAGES OF PARTNERSHIP
===========================
1. Lack of flexibility unlike the one-man show of a sole proprietorship;
2. Still cannot avoid the unlimited liability like the sole proprietorship;
3. Limited life when one of the partners withdraws or dies, then the partnership will dissolve by itself;
4. Conflicts amongst the partners might affect the stability of the partnership;
5. Capital though higher than a sole proprietorship but still limited compared to a limited company.
SALIENT POINTS TO NOTE:
=====================
The general practice is to have some form of agreement between the partners setting out their rights, duties and liabilities. This agreement is referred as the Partnership Deed.
The normal clauses in a Partnership Deed includes the following:
• Names of the partners and firm’s name;
• Nature of the business;
• Term of the partnership;
• Capital to be introduced by each partner;
• Profit and loss sharing ratios;
• Arrangements as to partners’ drawings and salaries;
• Arrangements regarding interest on capital, advances and drawings;
• Provisions regarding the retirement or death of a partner;
• Method of valuing goodwill upon retirement or death of a partner and
• Other details to be observed by partners.
MAJOR DIFFERENCES OF THE FINANCIAL STATEMENT OF A SOLE PROPRIETORSHIP AND PARTNERSHIP:
==================================================
Capital Account : In Sole Proprietorship (SP) only one capital account is prepared. In Partnership (PS) more than one capital account is prepared. The number of capital account in PS depends on the number of partners in the Partnership concern.
Profit / Loss : In SP all the profit belongs to the owner whereas in PS, profit and loss distributed to the partners’ capital account according to the agreed ratio.
Income Statement : No income statement is prepared in SP. The Income statement of the partnership shows a schedule on how the net profit/loss is distributed to the partners.
Balance Sheet : In SP, balance sheet shows only one capital account which belongs to the single owner. In PS, balance sheet shows the balance of the capital amount of each partner classified under owner’s equity.
Statement of Partner’s Equity : In SP, no such statement is prepared. In PS, besides the income statement and balance sheet, a Statement of partner’s equity is also prepared to show the changes in equity of each partner since the beginning of the year.
BREAK EVEN ANALYSIS
Introduction
============
Break-even analysis is a technique widely used by production management and management accountants. It is based on categorising production costs between those which are "variable" (costs that change when the production output changes) and those that are "fixed" (costs not directly related to the volume of production).
Total variable and fixed costs are compared with sales revenue in order to determine the level of sales volume, sales value or production at which the business makes neither a profit nor a loss (the "break-even point").
The Break-Even Chart
====================
In its simplest form, the break-even chart is a graphical representation of costs at various levels of activity shown on the same chart as the variation of income (or sales, revenue) with the same variation in activity. The point at which neither profit nor loss is made is known as the "break-even point" and is represented on the chart below by the intersection of the two lines:
In the diagram above, the line OA represents the variation of income at varying levels of production activity ("output"). OB represents the total fixed costs in the business. As output increases, variable costs are incurred, meaning that total costs (fixed + variable) also increase. At low levels of output, Costs are greater than Income. At the point of intersection, P, costs are exactly equal to income, and hence neither profit nor loss is made.
Fixed Costs
===========
Fixed costs are those business costs that are not directly related to the level of production or output. In other words, even if the business has a zero output or high output, the level of fixed costs will remain broadly the same. In the long term fixed costs can alter - perhaps as a result of investment in production capacity (e.g. adding a new factory unit) or through the growth in overheads required to support a larger, more complex business.
Examples of fixed costs:
- Rent and rates
- Depreciation
- Research and development
- Marketing costs (non- revenue related)
- Administration costs
Variable Costs
==============
Variable costs are those costs which vary directly with the level of output. They represent payment output-related inputs such as raw materials, direct labour, fuel and revenue-related costs such as commission.
A distinction is often made between "Direct" variable costs and "Indirect" variable costs.
Direct variable costs are those which can be directly attributable to the production of a particular product or service and allocated to a particular cost centre. Raw materials and the wages those working on the production line are good examples.
Indirect variable costs cannot be directly attributable to production but they do vary with output. These include depreciation (where it is calculated related to output - e.g. machine hours), maintenance and certain labour costs.
Semi-Variable Costs
===================
Whilst the distinction between fixed and variable costs is a convenient way of categorising business costs, in reality there are some costs which are fixed in nature but which increase when output reaches certain levels. These are largely related to the overall "scale" and/or complexity of the business. For example, when a business has relatively low levels of output or sales, it may not require costs associated with functions such as human resource management or a fully-resourced finance department. However, as the scale of the business grows (e.g. output, number people employed, number and complexity of transactions) then more resources are required. If production rises suddenly then some short-term increase in warehousing and/or transport may be required. In these circumstances, we say that part of the cost is variable and part fixed.
============
Break-even analysis is a technique widely used by production management and management accountants. It is based on categorising production costs between those which are "variable" (costs that change when the production output changes) and those that are "fixed" (costs not directly related to the volume of production).
Total variable and fixed costs are compared with sales revenue in order to determine the level of sales volume, sales value or production at which the business makes neither a profit nor a loss (the "break-even point").
The Break-Even Chart
====================
In its simplest form, the break-even chart is a graphical representation of costs at various levels of activity shown on the same chart as the variation of income (or sales, revenue) with the same variation in activity. The point at which neither profit nor loss is made is known as the "break-even point" and is represented on the chart below by the intersection of the two lines:
In the diagram above, the line OA represents the variation of income at varying levels of production activity ("output"). OB represents the total fixed costs in the business. As output increases, variable costs are incurred, meaning that total costs (fixed + variable) also increase. At low levels of output, Costs are greater than Income. At the point of intersection, P, costs are exactly equal to income, and hence neither profit nor loss is made.
Fixed Costs
===========
Fixed costs are those business costs that are not directly related to the level of production or output. In other words, even if the business has a zero output or high output, the level of fixed costs will remain broadly the same. In the long term fixed costs can alter - perhaps as a result of investment in production capacity (e.g. adding a new factory unit) or through the growth in overheads required to support a larger, more complex business.
Examples of fixed costs:
- Rent and rates
- Depreciation
- Research and development
- Marketing costs (non- revenue related)
- Administration costs
Variable Costs
==============
Variable costs are those costs which vary directly with the level of output. They represent payment output-related inputs such as raw materials, direct labour, fuel and revenue-related costs such as commission.
A distinction is often made between "Direct" variable costs and "Indirect" variable costs.
Direct variable costs are those which can be directly attributable to the production of a particular product or service and allocated to a particular cost centre. Raw materials and the wages those working on the production line are good examples.
Indirect variable costs cannot be directly attributable to production but they do vary with output. These include depreciation (where it is calculated related to output - e.g. machine hours), maintenance and certain labour costs.
Semi-Variable Costs
===================
Whilst the distinction between fixed and variable costs is a convenient way of categorising business costs, in reality there are some costs which are fixed in nature but which increase when output reaches certain levels. These are largely related to the overall "scale" and/or complexity of the business. For example, when a business has relatively low levels of output or sales, it may not require costs associated with functions such as human resource management or a fully-resourced finance department. However, as the scale of the business grows (e.g. output, number people employed, number and complexity of transactions) then more resources are required. If production rises suddenly then some short-term increase in warehousing and/or transport may be required. In these circumstances, we say that part of the cost is variable and part fixed.
Subscribe to:
Posts (Atom)