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10 Ways to Improve Productivity

improve productivity, Ways to Improve ProductivityThe new year is well under way and many of us are working with new, leaner budgets.  When we were developing these plans at the end of 2014, it seemed completely realistic that we could cut costs while maintaining our current sales volume.  Now that the holiday buzz has worn off and harsh reality has dawned, how do we actually make it happen?

10 Ways to Improve Productivity

The first, and most obvious way, is to get a handle on any costs that may have gotten out of whack.  Most of us were running pretty lean after the last economic downturn, but costs have a way of creeping back up when the economy improves and companies begin focusing on growth rather than survival.

Another thing to take a look at is pricing. Do key decision-makers understand the economics of your business and are prices set based upon these economics?  If you’re bidding jobs or setting prices on a 30% margin but your fixed costs are running 40%, then you clearly have a problem.  When was the last time you looked at your pricing?

You’ve made sure costs are under control and prices are in line with business economics. But what else can you do?  The answer is simple:  you seek out ways to improve productivity.  While the answer may be simple, the actual process of improving productivity isn’t always straightforward or intuitive.  We put together a tip sheet listing 10 ways to improve productivityClick here to check it out.

Best of luck to you in the new year!  If you have any tips or thoughts to add, please leave a comment below. Improve your pricing – and your profits– by downloading the free Pricing for Profit Inspection Guide.

improve productivity, Ways to Improve Productivity

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Variable vs Fixed Costs

See Also:
Absorption vs Variable Costing
Semi Variable Costs
Sunk Costs
Marginal Costs
Average Cost

Variable vs Fixed Costs Definition

In accounting, a distinction is often made between the variable vs fixed costs definition. Variable costs change with activity or production volume. In comparison, fixed costs remain constant regardless of activity or production volume.

All Costs

In accounting, all costs are either fixed costs or variable costs. Variable costs are inventoriable costs. That means accountants allocate fixed costs to units of production. Then they are recorded in inventory accounts, such as cost of goods sold. Fixed costs, on the other hand, are all costs that are not inventoriable costs. All costs that do not fluctuate directly with production volume are fixed costs. Fixed costs include indirect costs and manufacturing overhead costs.

Comparing Fixed Costs to Variable Costs

When comparing fixed costs to variable costs, or when trying to determine whether a cost is fixed or variable, simply ask whether or not the particular cost would change if the company stopped its production or primary business activities. If the company would continue to incur the cost, it is a fixed cost. If the company no longer incurs the cost, then it is most likely a variable cost.

Variable vs Fixed Costs Examples

To further help explain these costs, find a couple variable vs fixed costs examples below.

For example, if a telephone company charges a per-minute rate, then that would be a variable cost. A twenty minute phone call would cost more than a ten minute phone call. A good example of a fixed cost is rent. If a company rents a warehouse, it must pay rent for the warehouse whether it is full of inventory or completely vacant.

Other examples of fixed costs include executives’ salaries, interest expenses, depreciation, and insurance expenses. Examples of variable costs include direct labor and direct materials costs.

Variable vs Fixed Costs and Decision-Making

When making production-related decisions, should managers consider fixed costs or only variable costs? Generally speaking, variable costs are more relevant to production decisions than fixed costs.

For example, if a manager is deciding between keeping production levels constant or increasing production, then the primary factors in this decision will be the variable or incremental costs of the production of additional units of output. It would not be the fixed costs related to the operations that cannot be altered and will not change with the level of production. Therefore, in most straightforward instances, fixed costs are not relevant for production decision, and incremental costs, or variable costs, are relevant for these decisions.

If you want to utilize your unit economics to add more value to your organization, then click here to download the Know Your Economics Worksheet.

variable vs fixed costs, Variable vs Fixed Costs Examples, Variable vs Fixed Costs Definition

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variable vs fixed costs, Variable vs Fixed Costs Examples, Variable vs Fixed Costs Definition

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Segment Margin Example

See also:
Segment Margin
Margin vs Markup
Prepare a Breakeven Analysis
Budgeting 101: Creating Successful Budgets
Cost Volume Profit Definition
Variable vs Fixed Costs

Segment Margin Example

Segment Margin is important to a company because, most obviously, companies make profits off of their services and products. To acquire revenue from these services and products, a company would use a segment margin in order to determine whether the product has enough economical worth to continue producing. Therefore, it makes sense to provide an example so that segment margin can be viewed in a real life situation. An segment margin example is provided below.

Example And Explanation of Segment Margin

A shoe company, Fastbrink Shoes, has many different lines of shoe products and memorabilia that they sell to the public in order to make a profit. Because there are so many products, Fastbrink decides that they are going to trim down the number of products so that the most profitable and marketable products are getting the most attention. At the same time, they also want to eliminate the products that do not earn as much revenue as the more popular models and products. In one such case, Fastbrink has a line of basketball shoes that comes in two different colors, blue and black. Fastbrink wants to decide which shoe to keep and which shoe to scrap. Fastbrink will do this by calculating the segment margin for each shoe to determine which is the more profitable.

Segment Margin Calculation

It must be noted, first of all, that segment margin is calculated by taking the segment revenue of a product. This is essentially the revenue that is produced by a single product by itself. You then subtract the variable costs from the segment revenue and finally subtract the total avoidable fixed costs from that number to decipher the segment margin of a product. For this situation, the segment revenue for the blue shoe is $40,000 for the quarter while the revenues for the black shoe total $35,000. The variable costs for the blue and black shoes are $13,000 and $10,000 respectively. Finally, the avoidable fixed cost for both shoes is $10,000 for labor, parts, and machine maintenance. When calculated completely, the segment margin for the blue shoe comes out to be $17,000. Whereas, the black shoe segment margin totals $15,000.

Because the blue shoe rakes in $2,000 dollars more revenue that the black shoe, Fastbrink decides to discontinue the black shoe. As a result, profits on the blue shoe (more profitable model) can be maximized.

If you want to learn how to shape your economics to result in profit, then click here to download the Know Your Economics Worksheet.

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Segment Margin

See Also:
Segment Margin Example
Segmenting Customers for Profit
Net Profit Margin Analysis
Operating Profit Margin Ratio
Margin vs Markup
Profitability Index Method

Segment Margin Definition

Segment margin is a measure of profitability that applies to individual product lines. It is calculated as segment revenues minus variable costs minus avoidable fixed costs. It is also used to measure the profitability of a segment or product line when you make the decision of whether to continue or discontinue that segment or product line.

Segment Margin Calculation

Use the following formula to calculate segment margin:

SM = Segment Revenues – Variable Costs – Avoidable Fixed Costs

Segment Margin and Decision-Making

Segment margin separates relevant costs from irrelevant costs when analyzing a product line. For instance, if management is deciding whether to continue or discontinue a product line, the appropriate calculation for measuring the relevant revenues and relevant expenses for the decision would be to use this type of margin.

The difference between segment margin and other measures of profitability, such as contribution margin, is that it divides fixed costs into three categories. Consider one of the categories of fixed costs relevant when making decisions about the segment in question; the other two categories of fixed costs are irrelevant.

Segment Margin and Fixed Costs

The three categories include the following: avoidable fixed costs, unavoidable fixed costs, and common expenses. Avoidable fixed costs are relevant in the decision-making process of whether to continue or discontinue a product line. Whereas, unavoidable fixed costs and common expenses are irrelevant for decisions regarding a particular product line.

Avoidable fixed costs are those fixed costs that would not incur if you eliminated the segment or product line. Unavoidable fixed costs are fixed costs necessary for the continuation of the segment or product line. But those fixed costs would still incur if you discontinued that segment or product line. Eliminating the segment in question would merely cause the allocation of these unavoidable fixed costs to another segment. Refer to common expenses as expenses incurred by the company as a whole that are allocated to various segments or product lines.

If you want to increase the value of your organization, then click here to download the Know Your Economics Worksheet.

segment margin

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segment margin

Source:

Barfield, Jesse T., Michael R. Kinney, Cecily A. Raiborn. “Cost Accounting Traditions and Innovations,” West Publishing Company, St. Paul, MN, 1994.

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Semi Variable Costs

See Also:
Variable vs Fixed Cost
Absorption vs Variable Costing
Product Costs vs Period Costs
Sunk Costs
How to Estimate Expenses for an Annual Budget

Semi Variable Costs Definition

Semi variable costs are costs that include both a fixed and a variable component. They are also called mixed costs.

Semi Variable Cost Example 1

For example, let’s say you subscribe to a phone service that charges $40 dollars per month, plus $0.10 per minute for each additional minute beyond 500 minutes per month.

If you talk for less than 500 minutes per month, then the cost is $40 dollars per month. Beyond 500 minutes, the cost increases. This is an example of a semi variable cost. The flat rate of $40 dollars for 500 minutes is the fixed cost component. The additional $0.10 per minute for each additional minute beyond 500 minutes is the variable cost component.

Semi Variable Cost Example 2

Here is an example of a slightly different type of semi variable cost. For example, let’s say a manufacturing company has an electric bill that uses semi variable cost, including a fixed cost component and a variable cost component.

The electric company charges the manufacturing company a flat monthly rate of $300 dollars per month for basic electricity service. Then they charge $0.015 per kilowatt hour (kwh). In this example, the flat rate of $300 dollars per month is the fixed cost component. And the variable cost component is $0.015 per kwh.

If the manufacturing company uses 50,000 kwhs of electricity in a particular month, then its electric bill would be $1,050 dollars. ($1,050 = $300 + ($0.015 x 50,000kwhs)). And if the manufacturing company uses 100,000 kwhs of electricity the following month, then its electric bill would be $1,800 dollars. ($1,800 = $300 + ($0.015 x 100,000kwhs)).

Accounting Treatment

Cost accountants typically separate semi variable costs into their two distinct components – the fixed cost component and the variable cost component – when dealing with semi variable costs. Treat the fixed cost component separately as a fixed cost. Then treat the variable cost component separately as a variable cost. This may cause a differentiation of cost that does not reflect economic reality, but it makes it easier to handle and examine the effects of semi variable costs.

semi variable costs, Semi Variable Cost Example, Semi Variable Cost Definition

Source:

Barfield, Jesse T., Michael R. Kinney, Cecily A. Raiborn. “Cost Accounting Traditions and Innovations,” West Publishing Company, St. Paul, MN, 1994.

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Operating Leverage

See Also:
Homemade Leverage
Valuation Methods
Financial Ratios
Operating Profit Margin Ratio
Operating Cycle
What Your Banker Wants You to Know

Operating Leverage Definition

Operating leverage is a measure of the combination of fixed costs and variable costs in a company’s cost structure. A company with high fixed costs and low variable costs has high operating leverage; whereas a company with low fixed costs and high variable costs has low operating leverage.

High and Low Operating Leverage

A company with high operating leverage depends more on sales volume for profitability. The company must generate high sales volume to cover the high fixed costs. In other words, as sales increase, the company becomes more profitable. In a company with a cost structure that has low operating leverage, increasing sales volume will not dramatically improve profitability since variable costs increase proportionately with sales volume.

Contribution Margin and Breakeven Point

This term relates directly to a company’s contribution margin and breakeven point. Contribution margin is essentially a product’s selling price minus its unit-level variable cost. A product with proportionately less variable cost has a higher contribution margin. Hence, a product with a higher contribution margin corresponds with a production process that has high operating leverage – or higher fixed costs in relation to variable costs.

Similarly, a company with a high breakeven point has high operating leverage. The breakeven point refers to the level of sales volume at which per-unit profits fully cover fixed costs of production. In other words, it is the point at which revenues equal costs. Because more fixed costs translate into a higher breakeven point – more sales volume is required to cover the fixed costs – a production process with a high breakeven point utilizes high operating leverage. Of course, when a company with high operating leverage and a high breakeven point reaches sales volumes that exceed the breakeven point, a greater proportion of revenues generating are pure profit.


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Degree of Operating Leverage

The degree of leverage of a company’s cost structure is a ratio that measure’s the sensitivity of profits to changes in sales volume. In other words, this measures the degree to which a change in sales impacts profitability. In a company with high leverage, changes in sales volume magnify changes in profitability. Whereas in a company with low leverage the effects of fluctuations in sales volume impact profitability to a smaller degree. Divide the percentage change in the operating income by the percentage change in sales volume to find the degree of operating leverage. Use the following formula:

Degree of Operating Leverage = % Change in Operating Income ÷ % Change in Sales Volume

For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

Operating Leverage
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Operating Leverage

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Marginal Costs

See Also:
Marginal Cost Definition
Variable vs Fixed Cost
Sunk Costs
Marginal Costs
Average Cost
Breakeven Analysis

Marginal Costs

Marginal cost refers to the cost of producing another unit of output as production volume changes. As production volume changes the price of producing each additional unit of output changes. Marginal cost measures that change. It is also called differential cost or incremental cost.

Marginal Cost Example

Production costs consist of fixed costs and variable costs. Variable cost refers to the costs required for each unit of output. Fixed costs refer to overhead costs that are spread out across units of output.

For example, let’s say you make shoes. Each shoe produced requires seventy-five cents of rubber and fabric. Your shoe factory incurs $100 dollars of fixed costs per month. If you make 50 shoes per month, then each shoe incurs $2 of fixed costs. In this simple example, the total cost per shoe, including the rubber and fabric, would be $2.75 ($2.75 = $0.75 + ($100/50)).

But if you cranked up production volume and produced 100 shoes per month, then each shoe would incur $1 dollar of fixed costs, because fixed costs are spread out across units of output. The total cost per shoe would then drop to $1.75 ($1.75 = $0.75 + ($100/100)). In this situation, increasing production volume causes marginal costs to go down.

Marginal Cost Graph

The marginal cost graph is the shape of a U. As production volume increases the cost per unit declines. This is called economies of scale. When the combination of production volume and unit cost reaches the bottom of the U in the graph, the production process has reached its optimal volume. That point represents the most efficient and cost effective production volume level.

Beyond the point of optimal production level, increasing production volume causes the marginal cost to go up. Each unit of production becomes more expensive than the last. This is called diseconomies of scale. The production process has gone beyond its most efficient and cost effective production level and production is growing more and more costly. Beyond the optimal point at the bottom of the U in the graph, increasing production volume is making each unit more expensive.

Managers use marginal cost analysis to determine the optimal level of production volume in a production process.

To learn how to price for profit, download our Pricing for Profit Inspection Guide.

Marginal Costs

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