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