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Cost Behaviour in All the Stages of the Strategic Management

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“There are risks and costs to action. But they are far less than the long- range risks of comfortable inaction,” (John F. Kennedy). In an effort to improve productivity and subsequently operating income or revenue, knowing how a cost responds to a change in the level of activity makes it easier to create financial budgets and to forecast events and earnings. Cost behaviour refers to the demonstration of the changes in costs when output levels are changed. Management can influence cost behaviour through planning decisions and implemented policies. It is therefore imperative that cost behaviour is factored in all the stages of the strategic management process of the business– Formulating, Implementing and Evaluation.

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According to the Business Dictionary, cost is an amount that has to be paid or given up in order to get something. In business, cost is usually a monetary valuation of effort, material, resources, time and utilities consumed, risks incurred, and opportunity forgone in production and delivery of a good or service. Cost can be further divided into fixed, variable and mixed costs. Fixed Costs is likewise alluded to as constant, capacity, period or unavoidable ait refers to costs that are independent and autonomous of the production level within the short as costs remain the same in total in the short-run. Fixed cost per unit however, varies inversely with activity level therefore, as production volume increases, fixed cost per unit decreases and vice versa. Jones fixed costs of $100, 000 would remain unchanged as volume changes within the relevant activity range. If the relevant range however is exceeded, then total fixed costs would increase proportionately. This relevant range refers to the level of production within which unit variable or fixed cost will be unchanged.

For as long as a business is operating and carrying out activities, fixed costs will always be incurred. With this, it is critical to any company to maintain fixed cost at a satisfactory level.Assumed fixed costs of Gulf Coast Shrimp Company includes utilities, salaries, depreciation, taxes, insurance, advertisements among others. Despite fixed costs being alluded to as satisfactory by the accountant, there is room for improvement. In an effort to reduce costs and to subsequently improve operating profits it would be critical for Jones to shift some of the entity’s fixed costs to variable.

In addition, it is important to ensure that items are being used efficiently and to their full capacity. Variable Costs on the other hand, are costs that tend to move in relation to the volume of activity in the short-term. Total variable costs increase each time and additional unit is sold or produced. In comparison to fixed cost per unit variable cost per unit however, remains fixed/ constant. Variable Costs and units produced have a direct proportional relationship, therefore if one increases in total the other follow-suits. Similar to fixed costs, it is imperative that management seek to control variable costs and ensure that its unit price or cost drivers- factors that influence a change in cost- are maintained at the lowest and most competitive level.

Unlike fixed costs, variable costs are only incurred once unit produced or activity level is above zero. Assumed variable costs of Gulf Coast Shrimp Company includes direct materials, direct labour among others. Likewise, in an effort to reduce costs and to subsequently improve operating profits Jones must seek to reduce variable unit price, develop control procedures to ensure that materials are being used efficiently, direct labour hours are being used productively and are monitored for accuracy as well for other cost drivers identified. This will prove useful in reducing variable costs’ cumbersome outlay amounting to 70% of sales revenue.

In a different light, there are some expenses that consist of both variable and fixed costs. These are known as mixed costs. Like variable costs they tend to move in relation to activity but not directly, like fixed costs. Fixed costs are incurred over a specific range, while variable costs are then determined by the additional level of output. Regardless of the output quantity, fixed costs will be incurred. With this in mind, it is therefore important for management to ensure that costs are strategically formulated, implemented and evaluated.

Total Mixed Costs

It is imperative that businesses know the point in which its unit sales must be in order to cover all its expenses and thus generate profit. This point is known as the break-even point. According to the Business Dictionary, break-even refers to the point at which revenue received equals the costs associated with receiving the revenue. Gulf Coast Shrimp Company has fallen short of this point, as is obvious in its $10,000 operating loss it endured. Meeting one’s break-even point sets the premise of obtaining and maintaining profitability. The shortcomings of Gulf Coast Shrimp

Company need to be remedied quickly in any effort to maintain operations and the going-concern concept, especially because it is a small entity. Gulf Coast Shrimp Company may utilise the following recommendations in an effort to improve its operating profits and also reduce costs:

  1. In defining the bottom-line objective of achieving and maintaining high profits in the planning stage, Jones should ensure that costs are efficiently monitored during operations and evaluated against monthly revenues and profits. In doing this, Jones will be able to take corrective actions and remove unproductive elements timely.
  2. The variance between income and variable costs is alluded to as contribution margin. Gulf Coast’s steep variable costs have left little revenue to cover fixed costs. With this, an analysis of the structure of variable costs should be done so as to assess the importance and relevancy of each outlay and to ensure that they are being used and carried out efficiently. For example: Jones could review the job description of employees who are paid based on the units produced and see where the duties of these persons could be readjusted to include for more, therefore eliminating the need for a large staff base.
  3. Adopting utility saving measures is another remedy for reducing variable costs. Ensuring that machines and electric outlets are turned off when not in use will prove useful.
  4. Though fixed costs may be deemed satisfactory, based on industry standards this could be reduced and improved. Instead of owning all needed equipment, Jones could sell some Gulf Coast’s assets then engage in leasing equipment and asset at more reasonable costs, which would also eliminate some expenses such as repairs, maintenance, depreciation, insurance among others. For example, instead of owning an icehouse, Jones could sell this asset then lease it at a lower cost.
  5. Jones should also seek to generate additional revenue from the assets owned. Renting shrimp boats to a third party in off seasons or when they are not being used is one such measure.
  6. Similar to reducing the income of employees whose wages/ salaries varies with output, Jones may also review the salaries of fixed income employees and change it to variable. For example, an administrative worker who works only works three (3) days per week or less than eight (8) hours per day, salary could be adjusted and expensed at an hourly rate.
  7. Gulf Coast Shrimp Company should also develop standard costing procedures so as to minimize wastage and improve productivity and efficiency.
  8. After careful assessment of consumer sensitivity, market conditions and other expenditure, Gulf Coast Shrimp could increase the price per unit of products.

Concludingly, in any business that produces or sells items certain costs are usually incurred. Some of these costs are fixed, variable and mixed. Understanding how costs change in relation to changes in the activity output is a critical part of the decision-making process for management. This in turn ensures that appropriate forecasts are made suitable budgets are presentation, and the overall profitability of the company is maintained.

References:

  1. Maher, M., Lanen, William N, & Rajan, Madhav V. (2006). Fundamentals of cost accounting/
  2. Michael W. Maher, William N. Lanen, Madhav V. Rajan. (1st ed.). New York: McGraw-Hill/Irwin.
  3. BrainyQuotes, (2018). John F. KennedyQuotes. [online]Available at: www.brainyquote.com/quotes/john_f_kennedy_109216?src=t_costs[Accessed 22 Sept. 2018].
  4. BusinessDictionary.com. (2018). [online] Available at: http://www.businessdictionary.com/definition/cost.html [Accessed 22 Sep. 2018].In, L., CAT, F. and gassim, m. (2018). Cost Classification, Variable, fixed, semi-variablecosts. [online] Opentuition.com. Available at: https://opentuition.com/fia/ma1/cost-classification/ [Accessed 20 Sep. 2018].Staff, I. (2018). Break-Even Analysis. [online] Investopedia. Available at: https://www.investopedia.com/terms/b/breakevenanalysis.asp [Accessed 22 Sep. 2018].Staff, I. (2018). Contribution Margin. [online] Investopedia. Available at: https://www.investopedia.com/terms/c/contributionmargin.asp [Accessed 22 Sep. 2018].

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