Costs and income of enterprises (стр. 2 из 3)

There is another point from which costs may be considered. Part of used economic resources may be owned by a firm, owned by their respective owners. Another part of the resources the firm acquires from suppliers who are not owners of the firm. Thus, firm may have production facilities and equipment, vehicles, etc. At the same time, the company buys raw materials, fuel, energy, labor services, etc. Using any resource entails costs. Costs for use of own land is called rent, or internal rent, the costs of using entrepreneurial skills of company owner are called the normal profit, costs for use of company-owned industrial buildings, equipment and other items of real capital is called interest.

Thus, economists include into the economic costs of production all costs - internal and external, including rent into internal costs, normal profit and interest in order to attract and use resources in the competitive enterprise. Accounting costs are equal to the total external costs. From these definitions it follows that the economic costs are bigger than accounting costs for the amount of internal costs of the firm.

Accounting department registers production costs. The accountant records the actual costs that have occurred in the last period, determines the actual total costs in cash. If the production costs include only explicit costs, then their sum can be understated, and the difference between the proceeds from sales and explicit costs will be overstated.

Sunk costs (may be also referred as Fixed costs). There are also so-called sunk costs, which the company has spent, but won’t be able to recover. Sunk costs do not influence the firm’s decision-making on actions in future. But we can estimate the previous decisions that led to the emergence of sunk costs.

The volume of total cost of firm varies depending on the output Q. If the output increases, then total costs increase also. If production reduces, company’s costs also reduce.

The amount of some types of costs remains constant, independent of production volume. Fee for leased space, equipment, other costs remain constant, no matter how varies the production volume. The firm’s costs, the amount of which does not depend on the volume of output, called the fixed costs (FC).

At the same time, the costs of materials, fuel, energy, salaries and other change along with the output. If the production output stops, then such costs reduce almost to zero. With the growth of production variable costs increase, while the total value of fixed costs remains unchanged. Costs of production, the magnitude of which depends on the volume of output, called the variable (VC) cost of the firm. Total (TC), or gross, the cost to the company equal to the sum of fixed and variable costs: TC = FC + VC. Fig. 1 shows the line of fixed costs, variable costs and total costs curves. These forms of curves have most of the firms.

Fig. 1. Constant, variable and total costs of firm

So, there are:

Fixed costs:

Costs that don't change over a period of time and don't vary with output. E.g. salaries, rent, tax, insurance, heating and lighting. Fixed costs can also be called indirect costs as they are not directly associated with the final product. Fixed costs have to be paid even if the company is not producing any goods.

Variable costs:

Costs that vary directly with output so when output increases, variable costs also increase. E.g. raw materials, electricity. Variable costs can also be called direct costs as they are directly associated with production.

Semi-variable costs:

These costs have fixed and variable elements. E.g. a person working for the company may have a fixed salary but may also earn commission on sales.

Total costs are calculated by adding together fixed, variable and semi-variable costs.

2 Main ways of decreasing the costs

Production costs depend on the effective use of economic resources and are determined by the cost of unit of production.

In order to minimize costs, the company shall take the following action:

• what is the best way to organize the production of existing production facilities

• which new production capacities to choose taking into account scientific and technological progress;

• what is the best way to adapt to discoveries and inventions.

Correct solution of these problems should lead to profits.

Fig. 2 Graph showing the number of products in the function of minimum production costs

Isocost - is a graphic representation of the production function with a straight line, which shows all the combinations of factors of production, the use of which requires the same cost.

K - volume of production;

L - labor;

C0, C1, C2, C3 - isocosts;

Q = B * (K * L) – firm’s production function in the long run.

The curve of Q determines the volume of production, in which the enterprise should carry minimal level of costs.

Company can not select C0 isocost, as there is no such combination of factors that would provide the output Q when their value is equal to C0. Given volume of production can be achieved at a cost of C2, where the cost of capital and labor are, respectively: K2L2 at point A and K3L3 at point B, but in this case the costs will be minimal, so the chart shows that the most effective solution - the point N ( K1L1), which ensures minimization of production costs. Since prices on the factors of production change, C1 changes its slope to C3. Since the speed of capital increases, the best option would be the point M (K4L4), which ensures minimization of costs.

The equilibrium is determined by the terms of achieving maximization of profits. To achieve this, the firm must use variable resources in such quantities, that ratio of norms of technological substitution of one resource to another, equal to the ratio of prices of these resources.

Constant effect of production scale growth is characterized by the fact that the volume of production increases in the same proportion as the cost of resources.

P - price realization.

Negative effect of production scale growth is characterized by the fact that the output increases less than the cost of resources.

Positive effect of production scale is characterized by the fact that the volume of production increases in the proportion that exceeds the proportion of the increased costs of resources.

Main directions of reducing the costs of production:

1. The use of scientific and technological progress;

2. Improving the organization of production on the basis of productivity increase through reduction of working time wastes;

3. State regulation of economic processes (http://zubolom.ru/lectures/economy/28.shtml)

There is another essence of costs decreasing. Costs can be decreased if in the company was created the system of effective control over costs. Such system involves classification of costs, depending on how easily they can be adjusted using the alternative solutions, and consists of the following elements:

Cost Accounting.

Sometimes you can reduce costs by simply starting counting them systematically. It was noticed, for example, that when the company begins to record outgoing long distance and international calls to their staff on the date, time and purpose, the total number of calls is reduced due to a decrease of personal calls.

Staff’s support of cost accounting system.

Employees should be attracted to follow the cost accounting system. If there is a strong staff resistance to change cost accounting system the leader should explain the need to reduce costs, make staff understand that their proposals regarding savings are of high importance and will be valued in future (maybe financially).

Analysis of the causes of costs in the company.

Such analysis allows to take the necessary steps immediately to eliminate the causes of an undesirable increase in cost. Thus, if the entertainment expenditures rise, it is useful to determine why employees are spending company’s money in expensive restaurants. Company actively expands its clients base and the number of signed contracts grows? Or because the control over the entertainment expenditures became weak?

Tips to reduce costs could be as follows:

1. Categorization of expenses by clearly defined categories. For example, the cost of raw materials, labor, all direct production and general business

2. Focusing on the most significant costs, determine which of them should be adjusted.

3. Planning and implementation of cost reduction.

Nine approaches to reduce costs

This is general recommendation, the applicability of which is listed in the table. 1 (asterisks shows the relevance of activities from the list for those or other costs)

1. Know the measure. Do not spend more than necessary to your business now.

2. New or old partners. Try to negotiate more favorable terms with suppliers, contractors and other partners with whom you have worked before the crisis. If it is not possible to agree with old partners, find new partners, which may offer more favorable terms for you.

3. Horizontal integration. Develop horizontal integration, which involves joint purchases together with other buyer from one supplier. For example, two commercial companies can join to get discounts for large volume purchases.

4. Vertical integration. Develop vertical integration, which involves the development of close relationships with suppliers to control and possibly reduce the cost of materials and services.

5. To buy or produce. Check what components (materials, raw materials, etc.) your company may produce, and which are cheaper to purchase from other manufacturers.

6. Rent or own. Check what is cheaper: to rent a room (equipment, etc.) or buy it to use on the rights of the owner.

7. Forms of payment. Look for new payment options.

8. Tighter control. Simply create better control: consider the costs and they will be less.

9. Optimization of technological processes. Check whether it is possible to achieve savings through improved technological processes and work organization, for example, spending less raw materials per unit of output.

Activities or items that incur costs	1	2	3	4	5	6	7	8	9
The cost of raw materials	*	*	*	*	*	*	*	*	*
Rent payments	*	*	*	*	*
Utilities	*	*	*	*
Maintenance of equipment	*	*	*
Total economic costs (accounting, purchasing department, sales, training, etc.)	*	*	*
Other costs:
delivery	*
storage	*
loading and unloading, etc.	*
Marketing and advertising	*

Fig. 3 Table of activities and items that incur costs

(http://vuzlib.net/beta3/html/1/5575/5639/)

3 Main ways of increasing the income

Directed to production at lowest costs, the firm typically sees the problem not as a whole target but as means of solving much more general problem - the maximization of profit. This is the main goal for any company, even if it is not formulated as a leading motive for its activities.

In some cases, firms can aim not at maximizing profits, but other tasks, such as increased sales, achieving social recognition and for implementation of those tasks it sacrifices some part of its profits. Such motivation of firm’s behavior is called satisfactory behavior. However, even in this case one is in need of maximizing profits, at least in the long run, because only the desire for profit will rationally allocate resources, ensure high efficiency and, consequently, will allow successful implementation of the selected goal.

Profit maximization for the firm means finding ways to obtain maximum economic profit, thus the difference between total income and overall costs.

Pm = TR - TC

Pm - total or net economic gains;

TR - total revenue, defined as the product of the number of goods sold by its price;

TC - total costs, including both direct and indirect.

If the production and sales will be increased, then at constant prices the total revenue and total costs will increase: revenue - due to increased amount of goods sold, cost – due to the law of diminishing returns. Profits will occur as long as income growth will exceed the increase in costs, and its size will depend on the ratio of these quantities. Therefore, to solve the problem of profit maximization, it is important to consider not common, but limit values of the indices considered.

The amount added to the total revenue from each additional unit of output, would be a marginal revenue. And marginal costs are those costs that are added to the total costs with each unit of output.

As long as marginal revenue exceeds marginal cost, the firm makes a profit and, hence, it makes sense to increase output. But when the increase in income from the last unit of output equals the growth in production costs of this unit, the growth of production should be halted, because the increment to profits will be zero.

It is possible to formulate a general rule of profit maximization: The firm will increase output until the moment when additional costs of producing an additional unit of output equals the marginal revenue from its sale. This is called the rule MC = MR.

The difference between the MC and MR will be a marginal profit (PM) which was received from the sale of each additional unit of output. If MR> MC, PM indicator will be positive, indicating that each additional unit of output adds a part to the total profit. When the MR and MC equals to each other it will mean that PM = 0, and the total profit at this point reaches its maximum. Further growth of production would exceed the MC over the MR and PM takes negative values. In this case, when the marginal profit becomes negative, the firm can increase its overall profit by reducing the level of output.

Making decision about investing capital and about output of production, the firm can also focus on the average profit rate, which expresses the amount of profit per unit of output (Pm) / Q However, it should be borne in mind that the maximum average profit and the maximum total return does not match (http://revolution./economy/00006603_0.html).

What are other ways of increasing income for an enterprise?

Very often small business owners devote all their time working with every aspect of the company. Such deep involvement has its advantages, but if they do not interrupt and do not focus on the factors affecting the profitability of the company as a whole and in detail the result can be lower rates of profit.

The challenge to increase profitability requires the owner of the company to withdraw from daily activities and analyze the activities and financial statements of the company with an independent point of view, or in other words, as a third party. In this regard, accounting records are very important, as well as financial statements for evaluation of company’s history of commercial activities.

If the company's financial statements did not reflect the latest data, the financial records must be updated. This can be done either manually or using appropriate accounting software. This problem is often takes place in small businesses, because statements usually are prepared at the last moment and solely for tax purposes. Small businesses may be limited to simple accounting spreadsheets, while medium-sized businesses are encouraged to adapt more complex software.