economic analysis-complete - copy

8/6/2019 Economic Analysis-Complete - Copy

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FIXED COSTSA fixed cost is any expense that remain

constant regardless of level of Output.

These cost remain constant irrespective ofamount of business done and are not

affected by the volume of production.

Example: Salaries, interest on investment,insurance, periodical repairs ,depreciation

of building, plant machines etc.


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FIXED COSTS The important thing about fixed costs is

there is inverse relationship between the

level of output and fixed costs. As level ofproduction goes up the fixed costs per unit

of production begins to fall.

The fixed costs have to be incurred evenwhen there is no production.


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VARIBLE COSTS Variable costs are expenses that vary or

fluctuates with change in the level of output

In other words variable costs are costswhose total amount goes up or down when

the volume of production goes up or down.

Example: Cost of raw material , directwages,


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BREAKEVEN

CHART/ANALYSIS In order to obtain clear position of business (from

profit/loss point of view) it is important to construct

Break Even Chart. This chart shows Break Even Point i.e. point

where total costs line cuts the sales line i.e. this

point indicates the volume of sales (in rupees or

units of product) that must be achieved by the firmso that neither profit is earn nor any loss takes.


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BREAKEVEN

CHART/ANALYSIS This chart shows how much profit the firm

would earn or the loss it would suffer at

various volumes of production above andbelow the Break Even Point.

This analysis/chart is important in forming

conceptual framework for budgetarycontrol, profit planning, process selection


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BREAKEVEN

CHART/ANALYSIS-Assumptions All the costs are either perfectly variable or

absolutely fixed over the entire range ofproduction.

All revenue is perfectly variable with physicalvolume of production.

The volume of sales and the volume of productionare equal.

In case of multi-product firms, the product mixshould be stable.


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BREAKEVEN

CHART/ANALYSIS-Applications Highlights areas of economic strength and

weakness.

Helps to find out ways to enhance the profitability. Helps to take decisions in following: 1.Safety

Margins 2. Volume

needed to attain target profit 3.Change in price

and its effects 4.Wheter to expandproduction capacity or not


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BREAKEVEN

CHART/ANALYSIS-Applications5.Wheter to add a new product or drop

production of any product 6.Whether

to make or buy7. Selection of production machinery so as

to get maximum profit for a particular

volume of product from available machinery


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BREAKEVEN

CHART/ANALYSIS-Limitations1. BEA is based on accounting data hence its

usefulness depend on good accounting system

2.Costs data of the past period may not hold good

for the current period 3.Selling cost

may not remain constant 4.The cost revenue-

Volume relationship is linear, but this is realistic

only over narrow range of output

5.BEA is not effective tool for long range use and

its use should be restricted to the short run only.


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Make and Buy Decision Make or buy is a important consideration in

cost reduction/product improvement

programme.Advantages and disadvantages of all

possible alternatives (make/buy) should be

evaluated and one which gives minimumcost should be selected.


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MAKE This option requires appropriate production

equipment ,suitable workforce, materials,

space, supervisions, design, overheads,maintenance, taxes, insurance,

management attention and other hidden

and indirect costs.


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MAKE The advantages /positive points of this

option are as follows: 1. It provides work for

idle equipment and personnel 2.Shortendelivery period 3.Permits strict adherence

to the raw material specification 4.May cost

less than purchase 5.keep research and

design information secret.


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BUY This option permits lower investment in

facilities, smaller labour force, less handling

lower plant cost (for building and upkeep),less overheads and taxes, less problems of

labour management relations.

Allows manufacture by most efficient

equipment, lowers inventories (inprocess &

finished).


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BUYAllows change of design without loss of

investment in equipment and inventory


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Three Alternatives Before starting of new product the company

has three options:

1. Purchase the product complete from acontracted manufacture2. Purchase some components andmaterial and manufacture and assemble

the balance in own plant.3. Manufacture the product completely fromextraction of raw material


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Criteria forMake OrBuy Decision Finished product can be made cheaply by the firm

than outside supplier

Finished Product only be manufactured by limited

number of outside firms which are unable to meetdemand

The Part has an importance for the firm andrequires extremely close quality control

Requires high investment on facilities which arenot available at vendors plant

Whether the demands are large and stable


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When Company p

refe

rto buy

Company do not have facilities to make parts andthere are more other profitable options forinvestment of capital.

Exisiting facilities can be used more economicallyto make selected parts

The skill available is sufficient to make selectedpart (i.e. not all parts)

Patent/legal barriers prevent the company formaking the part.

Demand for the part is either temporary orseasonal


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Analysis for

Make/Buy Decision There are three approaches/methods

1.Simple Cost Analysis

2.Economic Analysis3.Break Even Point Analysis

economic analysis-complete - copy

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