Types of Costs
Cost structure can be generally denoted as the amount or type of fixed and variable cost that a business organization sustain. It is a notion that can be defined in smaller units, for example by product, product line, service, division, customer, or geographic region. If an organization is using a cost-based strategy, then Cost structure can be used as a tool for determining the price of any product, as well as to reflect some areas where there is some possibility for reducing the cost involved or at least resulting in better control on the product. Thus, it can be concluded that cost structure is a concept of management accounting and it has a relationship with financial accounting (Bragg, 2022).
There are generally three different types of costs that exist in the accounting and bookkeeping world. This includes the fixed cost, variable cost and semi-variable cost. An organization needs to understand this cost because it will help the entity to have a better grip on the amount of money spent in its production process. Understanding this cost will also help an entity determine expenses, create a budget as well as it will assist in developing revenue targets for the business.
Out of all the three costs fixed cost is considered one of the simplest types of cost. Fixed cost is such a type of cost that does not change irrespective of changes in the business activity of the organization. Examples of fixed costs can be rent or mortgage, salaries, property taxes insurance, interest payments and depreciation or amortization thus no extra calculation is required (Team, 2022). A variable cost on the other hand fluctuates with the level of production made in any organization. Some common examples of variable costs can include the cost of material required by the manufacturer for producing a particular product. The same amount of material is usually required for making the production of every unit of goods an entity sold. If an organization have access to the unit data, then the entity can easily project the cost involved based on a unit-by-unit basis. In addition to the variable and fixed costs, semi-variable costs may also get incurred by the organization. A semi-variable cost is generally a combination of both the cost categories discussed above. An example of a semi-variable cost can be the manufacturing cost involved in electricity. An essential amount of electricity needed to keep the lights on maybe a pretty fixed type of expense, on the other hand, the amount of electricity needed to run a machine used for manufacturing are usually get fluctuated with the number of units produced which can be the form variable cost of expenses (A Simple Model, 2022).
In the real world, it is very difficult to determine the existence of any direct connection between a product and its cost. Fixed cost of any product may be allocated based on the department capacity, ability of inputs or units to bear the cost, for instance, an organization may allocate a large amount of fixed cost to its high profit earning division while providing a smaller portion of this fixed cost in a slightly profitable division. As a result of this allocation, the view of a division or product may get twisted in order while showing true financial productivity. Until the fixed cost is properly allocated, the result of the information obtained may lead to the adoption of a faulty decision by the management of the organization.
Fixed Cost
In addition to this it is often seen that even though the semi-variable cost of the product assists the organization to improve efficiency as well as profitability, it also results in different types of limitation which is essential to be considered.
Firstly, an organization needs to make proper categorization of semi-variable costs between variable and fixed components. It is often overwhelming to make break up all cost into variable and fixed components if an organization has a considerable scale. Thus, it is very difficult to implement this strategy in a large-scale organization. Likewise, it is also very difficult to dissect the different types of cost involved and may lead to an incorrect analysis of period cost and product cost as a result of which it becomes a big issue for the management to make a correct decision since it is difficult to attribute the fixed cost to a particular unit produced in a year (Wikiaccounting, 2022).
Budgeting is a very important tool that plays a noteworthy role for achieving the target and improving the financial performance of any organization. Since every firm have a motive to make improvement in its organization performance, different types of structure and system were developed to ensure the growth of an organization in a profitable manner. In order to make planning for finance of any organization, the process involved in cash budgeting play an important role. Budgets generally forms a part of keeping management control which is developed for promoting an efficient use of the resources and also to provide support in the critical function of the entity. According to the statement of Moolchand, Narenda & Koshina, (2012) it was stated that the success of any budget preparation is mainly dependent on the attitudes of workers toward the budget and acceptance of the budget. The process involved in budgeting provides a framework for executing an important strategic decision and also ensure that the precious and limited resources of the organization are used effectively and in an efficient manner so that the organization target can be achieved.
When the worldwide covid 19 crises began to affect the organizations globally, the first and foremost response of the CFO and CEO of the organization was for survival of their firm that involve freeing up resources and cash of the organization. The liquidity crisis that arises due to the sharp disruption of the economic activities forced organization to move towards liquidity and cash to keep the operation going (mckinsey.com, 2022). During this time of uncertainty liquidity and cash play a dominant role. Thus, the decision that were taken based on budgeting related to cash flows can help the entity to determine the future route of the organization.
As a result of the growing importance of cash during the time of covid 19 crisis, it is essential for an organization to develop strategy for managing cash by preparing budget so that future business risk can be mitigated (grantthornton.pr, 2022).
If an organization will formulate and draw budget for their entity annually, it will help them to make an estimation of expenditure involved and receipt that an entity may get in a year, however in many organizations the process involve in budget may be characterized by differences between planned and actual budget. As per the study conducted by ACCA it was stated that a cash budget generally provides a summary of expected cash inflows and outflows of the organization over a particular period of time (aCOWtancy, 2022). CIMA in their official data describe the cash budget as a budget that is very detailed and have an estimation of inflows and outflows involved in both capital and revenue terms. In order to make an effective utilization of cash within an organization it is essential to prepare a cash budget by the financial manager of the organization. Many research has shown that budget play a very important role in management of an institution whether it can be a private or a public institution.
Variable Cost
The main objective of any budget is to have a control over the activities of the organization by delivering a roadmap for conducting activities within an entity and to provide a set of goals that an entity can achieve and also provide a means to reach these goals. According to Walther by creating a cash budget an organization can able to make projection of its sources and application of funds for future. Preparation of cash budget will help entity to determine a time of cash deficit occurred in a period so that corrective action can be taken to minimise the deficit, thus it can be concluded that during the time of recovering from covid 19 pandemic Cash budget will assist entity to develop financial performance (Eton, Fabian, & Benard 2018)
Since there exist a Heightened uncertainty and unpredictability due to the covid 19 crisis it may often become difficult to create a proper cash budget for the organization. Since during the time of crisis managers are required to take quick decision this frequent action of the managers may require the entity to go over or under the budget limits for justified reason (BCG Global, 2022). The preparation of budget is largely dependent on the accuracy of the forecasting, chiefly the forecasted future sales of the organization. This will not only affect the amount of cash that will arise in organization but also the time at which the entity will make receipt of cash an example can be credit sales in which the payment of goods gets delayed by I or 2 months whereas in seasonal sales entity have may large cash flows for some month and small amount of sales in other month. This creates a problem for the entity since the amount of cash outflows relating to production and day to day operation do not vary much. Thus, an organization may face shortage of cash during the budget period which must have to be covered somehow
References
A Simple Model, 2022. Cost Structure: Fixed, Variable and Semi-Variable | A Simple Model. [online] A Simple Model. Available at: <https://www.asimplemodel.com/insights/cost-structure-fixed-variable-and-semi-variable/> [Accessed 29 April 2022].
aCOWtancy, 2022. ACCA MA (F2) Notes: D2d. Cash budgets | aCOWtancy Textbook. [online] aCOWtancy. Available at: <https://www.acowtancy.com/textbook/acca-ma/d2-budget-preparation/cash-budgets/notes> [Accessed 29 April 2022].
BCG Global, 2022. Budgeting in an Age of Uncertainty. [online] BCG Global. Available at: <https://www.bcg.com/publications/2020/budgeting-in-an-age-of-uncertainty> [Accessed 29 April 2022].
Bragg, S., 2022. Cost structure definition — AccountingTools. [online] AccountingTools. Available at: <https://www.accountingtools.com/articles/what-is-cost-structure.html> [Accessed 29 April 2022].
Eton, M., Fabian, M. and Benard, P.O., 2018. Cash Budgeting and Organizational Performance of Private Firms in Uganda: A Case of Kabale District, Western Uganda.
grantthornton.pr, 2022. Importance of Cash Management During Turbulent Times. [online] Kevane Grant Thornton Puerto Rico Ltd. Home. Available at: <https://www.grantthornton.pr/press/press-releases-2020/importance-of-cash-management-during-turbulent-times/> [Accessed 29 April 2022].
mckinsey.com, 2022. strategy-and-corporate-finance/our-insights/moving-from-cash-preservation-to-cash-excellence-for-the-next-normal. [online] mckinsey.com. Available at: <https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/moving-from-cash-preservation-to-cash-excellence-for-the-next-normal> [Accessed 29 April 2022].
Moolchand, R. Narendra, R & Koshina, R-M (2012). Examining the Behavioural Aspect of Budgetingwith particular emphasis on Public Sector/Service Budgets. International Journal of Business and Social Science. Vol.3 No.13 (Special Issue-July 2012)
Team, B., 2022. Understanding Fixed, Variable And Semi-Variable Costs — BookKeeping Express. [online] BookKeeping Express. Available at: <https://www.bookkeepingexpress.com/blog/2016/1/19/understanding-variable-fixed-and-semi-variable-costs> [Accessed 29 April 2022].
Wikiaccounting, 2022. Semi-Variable Cost – Definition, Formula, And How to calculate – Wikiaccounting. [online] Wikiaccounting. Available at: <https://www.wikiaccounting.com/semi-variable-cost/> [Accessed 29 April 2022].
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