Marginal costing is an accounting term in which costs and
expenses are identified by their variability according to
the volume of goods bought or produced. By analysing costs
according to the variability in prices can significantly
improve profit efficiency levels within a business.
Business costs and expenses as expressed as a unit cost of
a product can vary significantly as purchase or production
volumes change. The first stage in using marginal costing
to generate higher levels of profit is to identify the
variability of all the individual cost elements.
Costs which are a component part of the product would
normally be classified as variable costs since each
component would require to be bought in specifically for
that product. The cost of items bought for resale would
also be classified as variable costs.
Fixed costs would be items not relating to the volume of
goods manufactured or sold. Examples would be the premises
costs, machinery costs.
A number of business expenses would be semi variable in
that they can in some circumstances be viewed as a fixed
expense but in other circumstances could also be viewed as
variable expenses. Advertising expenses might be regarded
as almost fixed expenses to promote the business or
products whereas promoting the business name would be
largely a fixed cost while specific product related
advertising might be viewed as a variable product cost.
Wages and salaries are an important cost to most businesses
and would normally be classified as semi variable.
Administration salaries are more likely to be fixed while
direct labour costs will contain both a fixed and variable
element.
To operate a marginal costing program identify the
variability of each cost item and evaluate that marginal
cost and the fixed overheads of the business. To use the
marginal costing as part of an accounting for profit
program apply different volumes to the marginal costs.
At the lowest volume the fixed costs might well exceed the
marginal profit, which in accounting terms is called the
contribution, being the difference between the selling
price and the marginal cost. The point at which the overall
volume produces neither a loss nor a profit is called the
break even point.
Break even analysis is important to ensure there is
sufficient market demand to be able to exceed the break
even point and the marketing effort will ensure that break
even point is not just reached but easily achievable.
A further stage in accounting for profit would be to plan
various volumes, the effect those volumes have on variable
costs and occasionally on fixed costs too. Determine what
is achievable and what is not achievable, the effect on the
volume of profit and set business plans accordingly.
In addition to higher volumes producing higher marginal
profits the variable costs also reduce when volumes
increase and these changes require to be accounted for.
Even if goods are being bought in purely for resale the
variable costs will vary with volumes.
Buying in 100 items of a product will be cheaper than
buying in 2 or 3. Selling and delivering the items
individually is likely to cost more in distribution co0sts
than selling in parcels of 10 or 20.
By analysing costs and their variability in relation to
actual and potential volumes gives the accountant a real
voice to influence management decisions in the way the
business plans are constructed and by routine checks on
progress using marginal costing as part of the budgeting
and reporting process maximum profits can be achieved by
accounting for profit.
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Terry Cartwright, accountant and CEO at DIY Accounting,
designs accounting software http://www.diyaccounting.co.uk/
on excel spreadsheets providing complete single and double
entry bookkeeping systems
http://www.diyaccounting.co.uk/bookkeeping.htm
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