# Cost Analysis - PowerPoint PPT Presentation

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Cost Analysis. Control costs Improve cost structure – problems show up Cost structure – relative proportion of each type of cost – fixed, variable, mixed Improve effectiveness of firm Which costs eroding profit margin What first? – earnings decrease Analyze situation, target problem areas.

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Cost Analysis

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### Cost Analysis

• Control costs

• Improve cost structure – problems show up

• Cost structure – relative proportion of each type of cost – fixed, variable, mixed

• Improve effectiveness of firm

• Which costs eroding profit margin

• What first? – earnings decrease

• Analyze situation, target problem areas

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• Cost behavior –

• Fixed – remain constant – i.e. equipment

• Variable – dollar amount varies in direct proportion to changes in activity level – i.e. Battery in car

• Mixed – contains both variable and fixed elements – license fee of \$25,000/year and \$3/dinner party

• Stepped costs – variable but increases in big chunks – i.e. Wages of maintenance workers

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• Make sure that costing done correctly, reduce costs

• Standard costing – assigning overhead costs based upon one predetermined rate based on volume

• Activity based costing - designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore affect fixed as well as variable costs.

• Most organizations maintain two costing systems – internal – most useful information.

• Uses drivers at various levels

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### Activity Based Costing

• Two stage allocation process

• Assign costs to pools, then assign to products using cost drivers

• I.e. Sell 50,000 CD units, 200,000 tape units = 250,000 units total

• Both require two direct labor hours to complete = 500,000 direct labor-hours

• Total manufacturing overhead = \$10,000,000

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### ABC Costing

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• Full capacity – constrained resource?

• Constraint – limited resource that could restrict company’s ability to satisfy demand – how used

• Theory of constraints

• Should not necessarily promote products with highest CM but rather promote the product with the highest contribution margin per unit of constrained resource

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• Value chain analysis – major business functions that add value to product and/or service

• Eliminate or minimize non-value activities

• Value-added activities – efficient as possible

• Costs of quality

• Prevention costs – plan the process to ensure that defects do not occur

• Appraisal costs – measure the level of quality to insure customer requirements

• Internal failure costs – rectify defective output before reaches customer

• External failure costs – costs associated with delivering defective output to customer

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• Effectiveness ratios

• Inventory turnover = COGS/average inventory – how frequently sells inventory

• JIT inventory system

• Lower costs by long-term contracts

• Closer relationship w/suppliers – guarantee deliver

• Reduce scrap by increasing quality

• Obsolete inventory on hand?

• A/R turnover – Credit sales/average accounts receivable – ability to collect cash from credit customers

• What is working?

• Reduce operating cycle – need less working capital – invest in more productive activities

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• Gross margin covers all costs - customers

• 80/20 rule – 80% of headaches come from 20% of customers – how to find them?

• Customer profitability – no problems

• Find all costs – product fulfillment cycle

• Some customers require extra work

• Extra sales calls, customer service, smaller transportation lots, smaller orders – all add to costs

• Expend effort on customers that are most profitable

• Drop services that don’t increase goodwill or profitable

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• Operating leverage – increase profitability

• Multiplying force – how sensitive is net operating income to percentage change in sales, if high a small percentage increase in sales can produce a much larger percentage increase in net operating income

• Mix of fixed versus variable costs

• Capital intensive vs. labor intensive

• Leverage multiplier - CM/NI

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• Theory of constraints

• Capital budgeting problems

• Read Introduction to ABC Costing