Posted by: Matthew Molinari | May 29, 2012

Determining Optimal Expense

No matter what the size of your business, you are always keeping an eye on the expenses that are being incurred by your company. The better you are at managing those expenses the more opportunity you have to earn more revenue (that’s a good thing). It’s pretty simple when it comes down to it.

 There are two basic types of costs: fixed and variable. Fixed costs are those that do not change regardless of how many units you are producing. Your rent or lease payment is probably the most basic example of a fixed cost; of course this is true unless you run a business that has a percentage based rent that increases along with your sales (which many restaurants have).

The other expenses are considered variable in that if you produce 5 units and your costs are Y when you produce 10 units your costs will be X+Y because it takes more time and material to produce extra product.

When you add those two costs together you get your total costs for operating your business. One thing to note is that fixed costs are only fixed for a certain period of time and eventually all costs are actually variable. If you take a loan out on your building, once it is paid off you no longer have that fixed cost.

So what does this mean for your supply chain? It means there are optimal points along the total cost line for your business depending on what your variable costs are and what the demand is for your product. If you are able to find your average fixed costs and your average variable costs you can determine you average cost which means you also know where you need to price your product to make a profit.

Your goal should be to drive down fixed costs because as you produce more your variable costs are going to increase. At some point the two will cross and it is at that point at which  you need to operate. This is your optimal operating level where you are producing the highest quantity at the lowest possible price.

Looking at your business, what is the most difficult cost to control and what techniques do you use to track and control it?


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