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Increase Profitability – Identifying fixed and variable costs

Jul 30Jeff Matthews

Over a long enough period of time all costs are variable, in the short range some costs are not variable with volume while others are.  Prime examples of variable costs are fuel costs and direct labor costs.  Some portion of labor may be fixed in the near term while other components are variable.  Overtime is an example of an expense that typically moves with increased volume or lower overall staffing levels.

Beyond your own common sense knowledge of your business, the best way to determine variable costs is to track the costs in logical categories and then calculate them as a percentage of volume or another variable measurement.  Another way to identify variable costs is to focus on how they are budgeted.  Are they a function of another expense or volume measurement?   Do shop supplies move in relation to labor hours?  Measuring cost categories over time will allow you to study their patterns and identify whether the category is variable or fixed.

I am a strong proponent of zero-based budgeting.  That sounds like a fancy term but it is a very common sense approach to budgeting.  Start with no expenses.  Determine your unit volumes and revenue.  Then focus on the cost to provide the products or services you are presuming in the sales forecast.  That will drive material costs, direct labor, fringe costs, shop expenses, equipment needs, outbound shipping costs and many other categories.  Look at your fixed costs in relation to your sales.  Will your current facilities and equipment support the volume projections?  Do you have too much space or equipment? Are you willing to reduce your space through  a sub-lease or moving to a different facility?  Are you willing to sell any of your equipment?

As you build a zero-based budget, document your assumptions.  When you later compare the actual results to your budget, you will be able to identify the “why” you missed a particular expense.  This is also excellent feedback for your next forecast or budget.

Consider a variable budget measurement for selected lines on your P&L.   Comparing to a static budget shows how you did against your base assumptions but by simply computing the variable expenses as a percentage of actual volume, you can determine if the actual costs are in line with your variable assumptions.  This is much more valuable management information.

B2B CFO® has over 200 experienced chief financial officers have deep knowledge of costs and budgeting that can be tapped to help grow your business.  A B2B CFO® can help you understand your financial picture and offer independent insight to improve your business’ profits.

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