Cost analysis


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Cost analysis

  2. 2. PRESENTED BY……….<br />
  3. 3. COST ANALYSIS<br />
  4. 4. IMPORTANCE OF COST<br /><ul><li> Regardless of industry in which a firm operates costs, are relevant and of major importance to efficient operation of that firm
  5. 5. The concept of cost is central to business decision making.</li></li></ul><li><ul><li>A firm which produces its goods and services at comparatively lower cost with a qualitative edge over its competitor will not only survive but also prosper.
  6. 6. Prices are determined by cost in all market structure
  7. 7. To make effective business decisions, the business manager needs to be aware of a number of costs concepts and their respective uses.</li></li></ul><li>VARIOUS COST TERMS ARE<br />Actual costs and opportunity costs<br />Opportunity costs<br />Marginal, incremental, and sunk costs<br />Replacement costs and historical costs<br />Book costs and out-of-pocket costs<br />Urgent costs and postponable costs<br />Fixed and variable costs<br />Total ,average and marginal cost<br />Short-run costs and long-run costs<br />Private costs and social costs<br />
  8. 8. ACTUAL COSTS AND OPPORTUNITY COSTS:<br /><ul><li>Actual costs are the costs which the firm incurs while producing or acquiring a good or a service like the cost on raw material, labor, rent, interest, etc.
  9. 9. The books of account generally record this information. The actual costs are also called the outlay costs or acquisition costs or absolute costs. </li></li></ul><li><ul><li> Opportunity cost can be defined as the cost of any decision measured in terms of the next best alternative, which has been sacrificed.
  10. 10. It is the comparison between the policy that was chosen and the policy that was rejected. </li></li></ul><li>Cont…<br /><ul><li>It can also defined as the revenue forgone foe not making the Best alternative use.
  11. 11. The concept of opportunity cost is useful for manager in decision making.
  12. 12. Opportunity cost or imputed cost are not actually incurred.</li></li></ul><li>INCREMENTAL & SUNK COSTS:<br /><ul><li>Incremental cost is the total additional cost that a firm has to incur as a result of implementing a major managerial decision.
  13. 13. Sunk costs are those costs which are incurred in the past or that have to be incurred in the future as result of a contractual agreement.
  14. 14. The cost of inventory and future rent charges for a warehouse that have to be incurred as a part of a lease agreement are examples of sunk costs.</li></li></ul><li>REPLACEMENT COSTS AND ORIGINAL (HISTORICAL) COSTS:<br /><ul><li>The basis of distinction between historical and replacement costs is the way in which the assets are carried on in the balance sheet and the manner in which the amount of cost is determined.
  15. 15. Historical cost of an asset states the cost of plant, equipment and materials at the price paid originally for them, while the replacement cost states the cost that the from would have to incur if it wants to replace or acquire the same assets now.
  16. 16. The differences between the historical and replacement costs result from price changes over time. </li></li></ul><li>BOOK COSTS AND OUT-OF-POCKET COSTS :<br /><ul><li>Out-of-pocket costs are those expenses which are current cash payments to outsiders.
  17. 17. All the explicit costs like payment of rent, wages, salaries, interest, transport charges, etc., fall in the category of out-of-pocket costs.
  18. 18. Book costs are those business costs which do not involve any cash payments but for them a provision is made in the books of account to include them in profit and loss accounts and take tax advantages.</li></li></ul><li>URGENT COSTS AND POSTPONABLE COSTS:<br /><ul><li>Urgent costs are those that must be incurred so that the operations of the firm continue, like the costs on material, labour, fuel, etc.
  19. 19. Those costs whose postponement does not affect (at least for some time) the operational efficiency of the firm, are: known as postponable costs, e.g., the maintenance of building, renovation of office etc.
  20. 20. This distinction of cost becomes quite obvious during the period of war or inflation when firms want to produce the maximum and postpone the maintenance of their plants, buildings, etc.</li></li></ul><li>CONTROLABLE AND NON CONTROLABLE COST<br />Controllable cost:<br /><ul><li>It is one which is controlled by the executive on whom the responsibility of the cost is wasted.</li></ul>Noncontrollable cost :<br /><ul><li>An allocated cost is noncontrollble.It varies with the formula adopted for allocation and is independent of the action of business personnel</li></li></ul><li>FIXED AND VARIABLE COSTS:<br /><ul><li>Fixed costs are those costs, which do not vary with the changes in the output of a product.
  21. 21. They are associated with the existence of a firm's plant and, therefore, must be paid even if the firm's level of output is zero.
  22. 22. Variable costs are those costs that vary with the level of output.
  23. 23. Variable costs increase but not necessarily in the same proportion as the increase in output.</li></li></ul><li>TOTAL COST, AVERAGE COST AND MARGINAL COST:<br /><ul><li>Total cost represents the money value of the total resources for production of goods and services by the firm.
  24. 24. Average cost is the cost per unit of output, assuming that production of each unit of output incurs the same cost.
  25. 25. Marginal costs are the incremental or additional costs incurred when there is additional to the existing out puts of goods and services. </li></li></ul><li>SHORT-RUN COSTS AND LONG-RUN COSTS:<br /><ul><li>The cost which incurred in the short period is called “Short Run Cost”.
  26. 26. All variable costs are incurred in short run.
  27. 27. Long run cost is one that is incurred by the firm in the long run.
  28. 28. All fixed cost incurred in long cost.</li></li></ul><li>PRIVATE COSTS AND SOCIAL COSTS :<br /><ul><li> Private costs are those which are actually incurred or provided for by an individual or a firm for its business activity.
  29. 29. If the decision of a firm to expand its output leads to increase in its costs, this cost will be known as private costs.
  30. 30. Social costs, on the other hand, are the total costs to the society or account of production of a good
  31. 31. Thus, the economic costs include both the private and social costs.</li></li></ul><li>DIRECT AND INDIRECT COSTS:<br /><ul><li>Direct cost means that cost which can be identified with and allocated to cost centres.
  32. 32. Costs which can be conveniently associated wholly with a particular unit of a final product.
  33. 33. Indirect cost means that cost which cannot be allocated but which can be absorbed by , cost unit.
  34. 34. Costs which cannot be associated or connected with a particular unit of the final product is termed as indirect costs.</li></li></ul><li>IMPLICIT AND EXPLICIT COSTS:<br /><ul><li>Implicit costs are where actual payments are not made for factors, such as self-owned land, self-owned capital, etc.
  35. 35. Implicit costs are the value of forgone opportunities that does not involve a physical cash payment.
  36. 36. Explicit costs can be defined as the costs which involves actual payment to other parties. </li></li></ul><li>COST FUNCTIONS<br /><ul><li>A cost function determines the behavior of costs with the change in output.
  37. 37. It indicates the functional relationship between total cost and total output.
  38. 38. If C represents total cost and Q represents the level of output, then the cost function is represented as C = f(Q)
  39. 39. It shows that the total cost of the firm depends on the output to be produced.
  40. 40. As no output is possible without input, increase in the input costs (e.g. raw materials) will lead to an increase in the total cost of production.</li></li></ul><li>COST – OUTPUT RELATIONS IN THE SHORT RUN<br /><ul><li>Short run cost functions help in determining the relationship between output and costs in the short run.
  41. 41. With a particular change in production output, the change in total, average and marginal costs can be determined for a given set of cost functions for a firm.
  42. 42. The short run average total costs (SRATC) and average variable costs (AVC) are slightly U-shaped.
  43. 43. The marginal cost (MC) curve intersects both the average variable cost curve and short run average total cost curve at their lowest points. </li></li></ul><li>
  44. 44. Marginal costs of nth unit(MCn) is the difference between the total costs of nth unit(TCn) and total costs of (n-1)th unit (TCn-1) i.e.,<br />MCn= (TCn-TCn-1)<br />Total costs increases through out at different rates. <br />Average and marginal costs first decline and then rises. <br />Marginal costs rises earlier than average costs.<br />
  45. 45. COST OF PRODUCTION<br /> Cost analysis plays a very dominant role in managerial economics as it is very much related to the fixation of price.<br />Determinants of Cost:<br />Size of plant<br />Level of production<br />Nature of technology<br />Process of various Inputs<br />Managerial & labour efficiency<br />
  46. 46. LEARNING CURVE<br />There are two type of curve:<br />
  47. 47. WHAT IS REVENUE ?<br /><ul><li>The nature and level of profit of the firm is determined by cost and revenue.
  48. 48. Cost implies that expenses made by the producer for the production of a commodity revenue.
  49. 49. It refers to amount of income which a producer receives by sale of output.</li></li></ul><li>TYPES OF REVENUE<br />TOTAL REVENUE :<br /><ul><li>Total revenue implies the total sale proceeds of firm by selling its total output at given price.
  50. 50. TR=PQ</li></ul> Where p = price<br /> q = quantity sold<br />
  51. 51. AVERAGE REVENUE :<br /><ul><li>Average revenue is the revenue earned for unit of is obtained by dividing total revenue by number of units sold.
  52. 52. AR=TR/Q
  53. 53. Where AR = average revenue</li></ul> TR = total revenue<br /> Q = quantity<br />MARGINAL REVENUE :<br /><ul><li>It is the net revenue earned by the producer by selling one more addition of a commodity
  54. 54. MR =D TR/D Q</li></li></ul><li>