The science of calculating the actual costs of manufacturing is known as cost accounting, a.k.a managerial accounting. Unlike traditional accounting which records economic transactions after they occur, cost accounting identifies all underlying costs associated with the production of a single unit.
Variable costs is a term used with cost accounting and it refers to those costs that must be incurred to produce or sell a service or a product. Variable costs include raw materials, cost of inventory, hourly wages, and in some situations, utilities. These costs are a part of the contribution margin formula of ‘Sales less Variable Costs equals Contribution Margin’.
Breakeven analysis is a managerial (cost) accounting tool used to examine the relationship of price to cost of a product. It also considers various sales volumes and the effect on profit given the different relationships of price to cost. The breakeven analysis is an essential tool in maximizing profit with the least amount of resources.
In the simple lever and fulcrum machine the force is magnified onto a load. The machine creates a mechanical advantage, a form of force amplification. In business the principle is exactly the same. Except here we are not moving a physical object but the objective is to amplify the profitability or financial gain by using some form of a lever and applying this lever to a fulcrum and generating financial advantage.
Many restaurant owners and managers do not understand the difference between their fixed and variable costs. The problem with defining fixed and variable costs in a restaurant relate to their connection with sales. In addition, reasonable assumptions have to be made in order to delineate between fixed and variable costs in the food service industry.
This article will explain the difference between fixed and variable costs in a restaurant, provide examples of both and educate the reader on proper analysis procedures to create baselines for improvement. I am a big believer in the feedback loop method of business operations in order to maximize profit and reduce overall stress for the owners and management team.
Mixed costs are a more advanced business concept. Mixed costs refer to a combination of both a fixed and variable component. A common error made by most small business entrepreneurs is the misapplication of the formula. Many small business owners understand the textbook definition but rarely exercise the concept in reality.
The hotel business has one tenet that stands above all other hospitality based business standards. Get heads on beds. Why does this one business standard have so much more value than any other? Well, it is simple, the fixed cost of operations for hotels are over 70% of all costs. Therefore any additional guest sleeping in one of the rooms adds significantly to the potential profit of the hotel.
In any industry, especially transportation, it is essential for the owner of a business to understand how much it costs per mile to operate his vehicle, trucks or fleet. The formula looks simple and in reality it is; but you must understand the underlying elements to truly appreciate and comprehend the calculation.
‘Fixed costs’ is a business term used mostly in cost accounting. It has several meanings based on its usage. The most common definition associated with fixed costs is expenses that must be paid regardless of production or sales volume. The best example is rent for a company. It doesn’t matter whether you produce or sell one widget or several thousand, the rent must still be paid.
So why is it important to understand fixed costs? How is it used in cost accounting and in financial reporting? Finally, what are examples of fixed costs?