Smruthi Krishnan – Dutch Uncles

Variable Cost in Business and Entrepreneurship

Smruthi Krishnan — Wed, 09 Jun 2021 06:05:05 +0000

Total expenditures incurred in production include costs to purchase factor inputs including labour, land and capital that are needed in the manufacturing process of a product. Cost refers to the total cost incurred by a business to produce a specific quantity of a product or offer a service. The total cost of production includes both fixed and variable costs. These expenditures include any kind of factor inputs like raw materials, human resources, capital machines, etc. For instance, production costs for building a factory will include expenses like cement, sand, rocks, labour, machines, tractors, cranes and mass-producing will require proper land allocated legally to builders. In the case of companies that offer services, they will require costs of setting up an office, material costs of setting up the services, payment to people who deliver the services and costs of delivering the services.

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Variable costs, unlike fixed costs, depend on the quantity of product produced and change accordingly.

Types of Costs of Production

A business runs only if the revenue or benefits of running the business is more than the costs incurred. During the manufacturing process, a business will incur different types of costs depending on the product or service they offer:

Fixed costs

Variable costs

Total cost

Total cost as mentioned before includes both variable and fixed costs. It takes into account all the costs incurred in the production process.

Average cost

The average cost is defined as the total cost of production divided by the number of units produced. You can also calculate it by adding up the average variable costs and the average fixed costs. The average cost per unit should always be minimised by the business so they can increase profit margins without raising the costs of production.

Marginal cost

Marginal cost is the expenditure that is incurred in producing one additional unit of output. It represents the rise in total cost due to an increase in production by one unit. Marginal cost can also be defined as the increase in variable cost due to an additional unit of the product being manufactured. If marginal costs are more than the marginal revenue, the firm won’t go ahead with the production.

More About Variable Cost

Variable costs, unlike fixed costs, depend on the quantity of product produced and change accordingly. Variable costs are sometimes called unit-level costs as they vary with the number of units produced. You can predict fixed costs at the beginning of the year but you cannot predict variable costs as they depend on production levels.

For instance, in our construction builder example, the cost of land and cranes and machines are fixed costs, utility bills are also fixed costs. These costs will be incurred irrespective of how long it takes to build the house/factory and how many units are built within that area to be sold. Wages, cement, electricity, sand, water on the other hand are variable costs. With the increase in production, you will need more workers and more raw materials and your variable cost would increase accordingly.

Variable costs are the sum of marginal costs over all units produced. They can also be considered normal costs. Direct costs are costs that can easily be associated with a particular cost object. But remember that not all variable costs are direct costs like variable manufacturing overhead costs are variable costs that are indirect costs.

Break-even Analysis and Variable Cost

Variable costs are very crucial when it comes to a company’s break-even analysis. Break-even analysis is used to determine the amount of revenue or the required units that must be sold in order to cover total costs. The break-even formula includes both fixed costs and variable costs and sales per unit:

Break-even Point in Units = Fixed Costs / (Sales Price per Unit – Variable Cost per Unit)

Consider the following example:

If a company is trying to determine the minimum units of goods that they need to sell in order to reach break-even every month. Assume that company sells only a single item: Pens. The fixed costs of running the company are Rs.15,000 and the variable costs of producing a single unit of pens are Rs.5 in raw materials and Rs.10 indirect labour. The company sells each pen at Rs.30 as a sales price. To determine the break-even point in units:

Break-even Point in Units = Rs.15,000 / (Rs.30 – Rs.15) = 1000
Therefore, for the company to break even, they would need to sell at least 1000 pens a month.

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If the variable costs increase at a rate that is more than the profits generated from new units produced, then expanding the business may not be the best decision to go about.

The formula for Variable Costs

The formula for calculating Total Variable Cost is extremely simple and is as follows:

Total Variable Cost = Total Quantity of Output x Variable Cost Per Unit of Output

As an entrepreneur, you must have a rough estimate of the total quantity of the output you are willing to produce and also the sale price of each unit of your product. By multiplying these two values, you can figure out the rough estimate of Variable costs you will need when you set out with your venture.

Fixed Costs become Variable over time

Fixed costs are not fixed permanently. They morphose into variable costs over time. They are fixed over months or years due to contractual obligations but after the contract is over, they can be varied. A company may have unpredictable expenses independent of production. For instance, land prices increase or decrease after a period of time, machines depreciate, technology evolves, etc and lead to changes in fixed costs. But there are no fixed costs in the long run. This is because all the short-run fixed inputs become variable in the long run.

Difference between Fixed Cost and Variable Cost

It is necessary to know how costs divide between variable and fixed costs. This helps in forecasting the earnings generated by various changes in unit sales and thus reflects the financial impact of marketing campaigns. By definition, costs that vary or change depending on the company’s production volume are variable while costs that do not change concerning production volume are fixed. In recent years, fixed costs gradually exceed variable costs for many companies. This is because automatic production increases the cost of equipment, including the depreciation and maintenance and also it becomes cumbersome to adjust human resources according to the actual work needs in the short term thus making labour a part of fixed costs.

When the level of production increases, total variable costs increase and when the production level decreases, total variable costs decrease. On the other hand, total fixed cost remains constant irrespective of the change in the level of production.

Example for Fixed vs. Variable Costs incurred by a builder

Depreciation of machine: Variable cost
Cost of shipping cement and other materials to construction sites: Variable cost
Cement used in manufacturing bread: Variable cost
Labour and construction engineer’s salary: Variable cost
Electricity used in manufacturing: Variable cost
Packing supplies for shipping products: Variable cost
Advertising costs: Fixed cost
Insurance: Fixed Cost

Variable Costs and Business Planning

Based on the market and product, many things are covered under fixed costs and variable costs distinctively. In business planning and management accounting, fixed costs, variable costs are different as compared to their usage in economics. In accounting, fixed costs broadly include almost all expenses that are not included in the cost of goods sold, and variable costs are those captured in costs of goods sold.

The distinction between fixed costs and variable costs is important when it comes to predicting the revenue earned via the changes in unit sales and thus important when it comes to calculating the financial impact of proposed marketing campaigns.

The level of variable cost is influenced by many factors, such as fixed cost, time period of project, uncertainties in production and discount rate. An analytical formula of variable cost as a function of these factors can be used to assess how different factors impact variable cost and total return in an investment.

Variable Costs and Growth Prospects

If there is a hike in production of a company in order to meet demand, their variable costs will increase. If the variable costs increase at a rate that is more than the profits generated from new units produced, then expanding the business may not be the best decision to go about. The company must pause and try to understand the reason why it is unable to achieve economies of scale according to which variable costs as a percentage of overall cost per unit decrease as the scale of production increases.

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Digital Infrastructure: Key to Entrepreneurial Success

Smruthi Krishnan — Sat, 08 May 2021 06:05:04 +0000

As generations pass by, the world evolves and transforms in more ways than one can imagine. Digital technology has changed the way industries work and how consumers live their lives. It has changed the demand and supply relationship across business platforms.

Brick-and-mortar businesses have recently shifted to the digital platform and are trying to create a digital presence in the current marketplace. Consumers are also increasingly using the Internet and mobile apps to purchase products and services from clothes, furniture to even basic necessities like medicines and groceries. As you would have observed, big-box retailers like Target and Best Buy have stepped up their digital game in recent years in order to increase their customer base and also to improve efficiency. Amazon started as a completely digital business even before they moved into brick and mortar stores on a limited basis. If you as an entrepreneur wish to know more about creating a digital business and improving technical aspects of business, this article is for you.

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Digital infrastructure and digital platform modernization have become more of a necessity today than an option.

What Is Digital Infrastructure?

Digital infrastructure refers to the digital technologies that build the foundation for an organization’s information technology and operations. These are important for the information technology capabilities region, city or organization. They also enhance and contribute to the economy and quality of consumerism and life. Examples of digital infrastructure include:

Internet Backbone:

They are the principle data routes by which continents, nations and regions connect networks to form the internet. This includes communications cables and facilities that are used by tier 1 networks for interconnection.

Fixed Broadband Networks:

Networks that connect regions and cities with wired internet are called Fixed Broadband Networks. These include last-mile connections to homes, centers, facilities and infrastructure.

Mobile Telecommunications:

Cellular networks that provide wireless broadband internet and communication services.

Communications Satellite:

Satellites that provide network or information services across continents.

Network Infrastructure:

Other network infrastructures such as Wi-Fi networks, modems, etc. come under Network Infrastructure.

Data Centers:

Facilities that manage computing, data storage and network services.

Cloud Computing Platforms:

Platforms that offer computing, data storage and network services on-demand. These are used for developing, deploying and operating software services.

Systems Software:

It is primarily concerned with automation. It is not really used as a tool for users. Applications Software on the other hand is used by people including mobile apps.

APIs & Integration Services:

These services permit various platforms, systems and applications to work together and share information. It has become so popular in recent years that it is an indispensable part of the economy.

User Devices:

Devices such as mobile phones, laptops, IoT Robots, machines, sensors, facilities, fall under this category.

Why Is Digital Infrastructure Important to Your Business Overall?

Digital infrastructure and digital platform modernization have become more of a necessity today than an option. It helps a business become smarter whilst enabling the organisation to enhance the quality of experiences and production in order to meet customer demands and employee productivity. As we read earlier, consumers across the globe are switching to the internet like never before. They are becoming increasingly hyper-connected and catching up with the technological changes.

Everyone wants the latest thing on the market, everyone wants more of everything. If your business or venture cannot keep up with consumer demand, there will be another company that will step in to fill that gap.

Now is the best time to invest in infrastructure, security servers and cloud-computing platforms, before it’s too late and you get left behind while everyone else moves ahead. Research more on your digital infrastructure strategy and include micro-services and lightweight API-led application interfaces, etc to keep up with the latest trends in technology.

How can Modernizing Digital Infrastructure help improve business and add value for customers?

The crux of any entrepreneurship model is to provide solutions to certain problems of consumers such that it optimises consumer satisfaction as well as producer profits. Modernizing your ventures with the latest technology is one step towards achieving that optimisation. The digital infrastructure allows businesses to connect and share relevant data through responsive platforms and mobile apps thus increasing their customer base and sales. This also improves the user experience for your customers as they can avail services conveniently and easily without even stepping out from the comforts of their home. Employees also improve their productivity with improvement in technology as when labour is amalgamated with digital technology, it improves the efficiency of working. The digitalization helps increase engagement and interlinks consumers and producers making the market a more trustworthy landscape where proper relations are maintained.

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In the post-pandemic era where every business is going digital and online, these changes can have huge impacts and can metamorphose the entrepreneurial landscape.

Digital Infrastructure: Key to Success

The global economy has become an extremely competitive market place with indefinite opportunities for disruptions and it demands constant innovation. Digital infrastructural changes have transformed the IT industry and the way it impacts the business landscape.

The success of any venture now depends on a combination of user experience, appealing business models and rapid time-to-value. This requires fundamental changes in the role of IT and digitalization in the industry. With the introduction of innovations and disruptive business models, the IT estates are being remodeled constantly. Digital Infrastructure focuses on enabling business agility and powering user experiences that drive customer engagement and loyalty.

In a hypercompetitive world, business agility reflects the ability to rapidly respond to the changing needs of the business. The digitalization of any business should include rapid creation, building and deployment of new products and services. Digital Infrastructure should offer the business a consumer-grade experience, with easy discovery and click-to-consume services.

The recent acceleration in the development of cloud services is an exemplary example of digital change. Though cloud migration was developed to save costs, the reason why several new digital leaders are switching to cloud services is due to the levels of business agility required for rapid delivery of the recently found experience-focused services. The key role of digital infrastructure is to rapidly enable such services. Businesses tend to prioritize quick orchestration of new offerings that will leverage existing capabilities. The ability to both Orchestrate and Automate business services is gradually becoming the core and central function within Digital Infrastructure.

Continuous Delivery and DevOps are a part of digital infrastructural changes which focus on speed to value and provision, deployment and management of services at will. Gradually this is becoming the very crux of the Digital Infrastructure industry. The digital landscape focuses primarily on consumer experience, which is why delivery speed, efficiency, reliability, etc are becoming more important when it comes to the core functioning of businesses.

Conclusion

Organizations across industries are embracing the change in digital infrastructure as a means to solve complex business problems and to improve customer retention, marketing responses, fuel savings and quality defects. In the post-pandemic era where every business is going digital and online, these changes can have huge impacts and can metamorphose the entrepreneurial landscape.

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How does the Government Regulate Drug Pricing?

Smruthi Krishnan — Sun, 02 May 2021 07:30:04 +0000

Regulation of drug prices is a very important aspect when it comes to the pharmaceutical industry. These companies can function relatively unregulated and can raise drug prices beyond inflation rates allowing them to increase revenue despite sluggish demand. This is where the government intervenes with regulation policies which mainly revolve around price controls. Pharmaceutical companies oppose drug pricing reform arguing that lowering the cost of prescription medications will hinder innovation. However, such high surges in drug prices can affect the economic status and health conditions of citizens.

Drug Pricing in the absence of regulations depends on the following factors

Uniqueness

If the market is saturated with the same drugs to treat a certain illness then the price of new drugs innovated for the same illness will be lower. Uniqueness is important when it comes to setting the price.

Competition

The popularity and success of the drug’s competition determine the price of the drug. If the drug provides additional benefits then it will have a higher price.

Research and Development

The amount of time, effort, and money that a pharmaceutical company invests in the R&D for each drug must be weighed when the drug is priced.

Effectiveness

The new drug should be able to change the current way of treatment of the illness like preventing the need for certain medical treatments or surgeries, etc. They should be more effective in treating the illness and saving other costs for consumers.

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The price ceiling policy in India placed more than two decades ago has led to India having one of the lowest drug prices in the world.

How Governments Regulate Drug Pricing

If drug prices are too high, consumers may not go for it. Health insurance payers may not allow reimbursement and physicians won’t prescribe it. To ensure affordability and a proper healthcare system, the governments initiate price control policies that make drugs cheaper and easily accessible to everyone which is necessary for a country where most of the citizens cannot afford medications.

The price ceiling policy in India placed more than two decades ago has led to India having one of the lowest drug prices in the world. However, the information asymmetry between the buyer and the seller has led to black markets and the selling of spiked drugs. Prices of essential drugs are regulated by the Indian central government under the Essential Commodities Act, 1955.

In 1997, the National Pharmaceutical Pricing Authority was set up to revise prices of drugs, enforce the Drug Price Control Order (DPCO) and monitor the prices of drugs. Today, the DPCO lists 851 drug formulations whose prices can be capped based on certain dosages.

The ceiling price is set as the average price for all brands selling a particular drug with more than 1 percent of the market share. If the price of a drug is below the ceiling price, it can be raised only after a year. Patented drugs or fixed-dose combination drugs are exempted from this policy.

Impact of Drug Pricing

The drug price control policy has led to many pharmaceutical companies going out of production causing substandard and spurious drug manufacturers to thrive in the industry. With poor regulations, there is a trade-off between price and quality leading to several black markets for drugs, selling of fake drugs or dangerous drugs to patients in need. Sale of cap priced drugs reduced while those without any cap increased. Medications for diseases like HIV or cancer are not on the list and hence their drug prices remain sky-high.

However, price controls help poor consumers to opt for a recognisable brand instead of settling for fake medicines. It increases affordability and accessibility for patients across the country. However stricter guidelines and more transparent information about drugs and drug companies are required to ensure an efficient system.

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An Insight into Real Estate

Smruthi Krishnan — Sat, 01 May 2021 07:35:03 +0000

Real estate is a part of your property that consists of land and the buildings on it. It also includes natural resources such as crops, minerals or water; immovable property of this nature; an item of real property like buildings or housing. Real estate involves property, land, buildings, air rights above the land and underground rights below the land. The term real estate itself means real, or physical, property. Real estate is different from personal property. Personal property is not permanently attached to the land, such as vehicles, boats, jewellery, furniture, tools and the rolling stock of an agricultural farm.

Examples of Real Estate

Several examples fall under the ambit of real estate. Each of these differs in definitions in terms of size and type of property.

Single-family dwelling: A house designed for only one family
Multi-family dwelling: A group of houses designed for more than one family like a housing society
Attached: Any unit that’s connected to another unit and is not a separate dwelling
Apartment: An individual unit in a multi-unit building. The boundary limits are set by doors and walls and differ in the number of rooms and floor space. For instance: multi-story apartment buildings. The size of an apartment or house can be described in square feet or meters. In some countries it counts only living space and excludes other non-living spaces while in other places like Europe it reflects the total area of the walls enclosing the home, thus including any attached garage and non-living spaces.
Multi-family house: Multi-story detached buildings where, unlike flats where there is more than one unit on each floor, these houses have a separate apartment or unit on each floor.
Terraced house: Several single or multi-unit buildings in a continuous row with shared walls and no intervening space. For example townhouses or row houses.
Condominium (Condo): A building with individual units owned by individual people. Common grounds and common areas within the complex are owned and shared jointly.
Detached house: A free-standing building not connecting to anything else. For example a small bungalow.
Portable house: Houses that can be moved on a flatbed truck
Mobile home: A vehicle on wheels that has a permanent residence attached to it
Hut: A dwelling typically made of raw materials such as bamboo, mud, and clay. For example kaccha houses in Indian chawls and village areas. They are also found in urban poor areas.
Cooperative: A type of multiple ownership in which the residents of a multi-unit housing complex own shares in the cooperative corporation that owns the property, giving each resident the right to occupy a specific apartment or unit.
A studio apartment has a single bedroom with no living room with a tiny separate kitchen.
A one-bedroom apartment has a living or dining room separate from the bedroom. Two bedrooms, three-bedroom, and larger units are common.
Other categories include Chawls, Villas, Havelis whose size is usually measured in Gaz (square yards), Quila, Marla, Beegha, and acre.

Characteristics of Real Estate

Immobility: The geographic location of any piece of land can never be changed. It remains the same forever. You can alter the topography, you can move the things on the land sometimes like turning farms into houses or houses into farms but the location remains the same. You cannot transport land.

Indestructibility. The land is durable and indestructible. It can lose its quality due to soil erosion or water pollution or even during floods and landslide but the piece of land remains intact even after the storm passes.

Location or area preference. Location is the most important economic characteristic of the land. People have choices and tastes when it comes to a given area which is called location. They base their location preferences on factors like reputation, proximity to work, convenience, etc.

Scarcity: The total supply of land is fixed and cannot be changed. It is a resource that cannot be created by technology or produced artificially. We have a limited supply of land.

Improvements: Private nature improvements like homes and fences are referred to as improvements on the land while on the other hand improvements like sidewalks and sewer systems which fall under public nature are called improvements to the land. Both of these add value to the property.

The permanence of investment: Improvements like drainage, electricity, water, and sewer systems can’t be removed or replaced economically and thus remain constant.

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Real estate is different from personal property. Personal property is not permanently attached to the land, such as vehicles, boats, jewellery, furniture, tools and the rolling stock of an agricultural farm.

Four Types of Real Estate:

Residential real estate: Includes new construction and resale homes. The most common category is single-family homes. There are also condominiums, co-ops, townhouses, duplexes, triple-deckers, quadplexes, high-value homes, multi-generational and vacation homes.

Commercial real estate: Property for commercial purposes like shopping centres and strip malls, medical and educational buildings, hotels and offices. Apartment buildings are often considered commercials as they mass produce homes to produce income.

Industrial real estate: Includes manufacturing buildings and property, as well as warehouses. The buildings can be used for research, production, storage, and distribution of goods.

Land: Consists of vacant land, working farms, and ranches. The subcategories within vacant land include undeveloped, early development or reuse, subdivision and site assembly.

Real Estate Industry

The real estate market involves producing, buying and selling real estate. By producing we mean building houses, apartments, factories and putting them on sale with the added value. Several people participate in the real estate market as a business opportunity and several others engage in it for their own homes. Real estate affects the economy by being a critical driver of economic growth. The construction of new buildings is a component of gross domestic product. It includes residential, commercial, and industrial buildings. Indian real estate sector has witnessed high growth in recent times with a rise in demand for office as well as residential spaces. Real estate attracted around Rs. 43,780 crore (US$ 6.26 billion) in investment in 2019.

Real estate agents are experts who assist homeowners, businesses and investors in buying and selling properties. Sellers’ agents help them find buyers and price your property, using comparative listings of recently sold properties in the market. They assist in negotiations with the buyer, helping you get the highest price possible.

Buyers’ agents are well researched on the local market and provide similar services for the home purchaser to find a property that meets the buyer’s criteria. Buyers’ agents negotiate prices, help with the legalities of the process, etc.

If you choose to invest or venture into the real estate market, make sure you read up on current market prices and trends, follow up on booms and blows in the sector and make well-researched choices. Depending solely on brokers or agents may not always be the smart choice as they might take advantage of you.

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Real estate affects the economy by being a critical driver of economic growth. The construction of new buildings is a component of gross domestic product.

Real Estate Investing

Anyone who buys or sells a home is engaging in real estate investing. Several questions pop into one’s mind like will the house rise or fall in value while you live in it? How will future interest rates and tax affect you if you get a mortgage?

There are several ways to invest in real estate and several people take it up as a successful business. Some of the most common ways to invest directly include:

Homeownership
Rental properties
House flipping

Flipping a house involves the purchase of a house to improve then sell it. Rentals include buying houses but letting other people stay in them for a fixed amount per year/month. Many people own several homes and rent them out. Nowadays several investors use Airbnb as a convenient way to rent out all or part of their homes especially for converting their homes into vacation houses in tourist areas. You can make money in two different ways: Revenue from rent or leases, and appreciation of the real estate’s value.

Investing in the real estate business has lots of long term gains unless the prices hike too much and the bubble bursts like the US crisis which started with the real estate boom. Factors such as employment rates, the local economy, crime rates, transportation facilities, school quality, municipal services, and property taxes can drive real estate prices up or down. This is why you must be aware of where we are in the current business cycle. It can be extremely risky to start if the chances are that the real estate market is going to crash.

Advantages

Offers steady income
Offers capital appreciation
Diversified portfolio

Disadvantages

Is usually illiquid
Influenced by highly local factors
Requires big initial capital outlay

Indirect Investment in Real Estate

One can invest in housing without buying a home by purchasing stocks of homebuilders. Their stock prices rise and fall with the housing market. Another way is with Real Estate Investment Trusts, called REITs in commercial real estate. These are companies that hold a portfolio of income-producing real estate.

There are several broad types of REITs, including equity, mortgage, and hybrid REITs and they also classify based on how their shares are bought and sold as Publicly traded REITs, Public non-traded REITs and Private REITs. Their stock prices lag behind trends in residential real estate by a few years. You earn income from REITs through dividend payments and appreciation of the shares. You can also invest in real estate mutual funds and real estate exchange-traded funds. REITs are very liquid and transparent as the shares trade like any other security traded.

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Can the Government Control COVID Vaccine Prices via the DPCO?

Smruthi Krishnan — Sat, 01 May 2021 05:35:04 +0000

As the pandemic continues to rage on in India, with cases spiking up and reaching new peaks, vaccinations have become a necessity for survival. With millions of people spending loads of money in search of oxygen cylinders, hospital beds and medications, the healthcare system is on the edge of an apocalypse. If vaccine prices are too high, consumers may not go for it. Health insurance payers may not allow reimbursement and physicians won’t prescribe it.

How Governments regulate drug prices via DPCO?

Governments can regulate drug pricing to ensure affordability and accessibility. They initiate price control policies that make drugs cheaper and easily accessible to everyone which is necessary for a country where most of the citizens cannot afford medications.

For instance, consider the price ceiling policy in India which was placed more than two decades ago. This led to India having one of the lowest drug prices in the world. Prices of essential drugs are regulated by the Indian central government under the Essential Commodities Act, 1955.

1997, the National Pharmaceutical Pricing Authority was set up to revise prices of drugs, enforce the Drug Price Control Order (DPCO) and monitor the prices of drugs. The Drugs Prices Control Order, 1995 is an order issued by the Government of India under Sec. 3 of Essential Commodities Act, 1955 to regulate the prices of drugs. The Order provides the list of price controlled drugs, procedures for fixation of prices of drugs, method of implementation of prices and penalties for contravention of provisions. Today, the DPCO lists 851 drug formulations whose prices can be capped based on certain dosages.

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The Drugs Prices Control Order, 1995 is an order issued by the Government of India under Sec. 3 of Essential Commodities Act, 1955 to regulate the prices of drugs.

Can DPCO regulate COVID Vaccine Prices?

The COVID-19 pandemic has become a national crisis and certain areas of the Drugs Control Act can be leveraged to deal with the situation. Different manufacturers are quoting different prices which leads to the question whether vaccine prices can be regulated by the DPCO?

Regulation through DPCO is not applicable for patented drugs or fixed-dose combination (FDC) drugs which is why the price of the antiviral drug remdesivir used to treat serious cases of COVID-19 cannot be regulated by the government. Globally, the American biotechnology firm Gilead Sciences owns the patent for the drug and other companies have taken a licence from Gilead to manufacture remdesivir.

However, amendments can be proposed to bring vaccines or drugs used in the treatment of COVID-19 under the DPCO policy. It is necessary the government ensures free or atleast much lower, capped and equitable prices to ensure accessibility to citizens who otherwise cannot afford the vaccine. During a national crisis like this, where the country is on the blink of collapsing, the government must take all steps to protect its citizens and keep them healthy.

Other Legal Provisions Suggested

THE PATENTS ACT, 1970 was mentioned by the Supreme Court which can help the government regulate the pricing of the vaccine. Section 100 of the Patents Act gives the central government the power to authorise any pharmaceutical company to use the invention for the “purposes of the government”. This will help the government to license the patents of the vaccine to speed up manufacturing and ensure equitable pricing.

On the other hand, THE EPIDEMIC DISEASES ACT, 1897 proves to be a huge weapon for the government in dealing with the pandemic. It gives the government the power to take special measures and prescribe regulations as to dangerous epidemic disease.

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What is the Internal Rate of Return in Finance and Accounting

Smruthi Krishnan — Mon, 19 Apr 2021 04:35:04 +0000

Internal Rate of Return has been used as a tool of profitability measurement for ages and has been recommended in various finance texts. Companies often discount the cash flows they receive before they try to calculate their payback period. They basically try to figure out how many years a project has to last so that it is advantageous when seen from the Net Present Value perspective. If the value of cash flows do not exceed the initial outlay, the discounted payback rule will reject the project. While if cash inflows exceed the initial outlay, long term projects continue to exist without the risk of rejection.

Discounted Cash Flow or Internal Rate of Return

We always accept investment opportunities offering rates of return in excess of their opportunity costs of capital. The rate of return that generates a single payoff after one period is calculated by dividing the payoff with the investment and subtracting 1 from that value.

If we write Net Present Value (NPV) and try to find a discount rate that makes NPV=0, we find out that the discount rate that makes NPV=0 is nothing but the rate of return.

Now, this is for projects that generate payoffs in a single period. When we extend this concept to projects that produce cash flows in several periods, we get the project rate of return as the discount rate which gives zero NPV. This discount rate is known as the discounted cash flow rate of return or internal rate of return (IRR).

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We always accept investment opportunities offering rates of return in excess of their opportunity costs of capital.

Calculating IRR

The calculation of IRR is based on trial and error. Initially, we try a zero discount rate which gives us NPV positive. Since NPV is positive, IRR must be greater than zero. Then we try a discount rate of 50%, for instance if the NPV comes out to be negative. This implies that IRR is less than 50% and we keep doing this till we achieve NPV=zero at a particular discount rate. Usually, finance accounts plot graphs either manually or using computers to show the relationship between net present value and a range of discount rates. We finally figure out that at a discount rate of x%, the net present value is zero and thus the IRR is x%.

Most often, the most convenient way to calculate the IRR is to plot three or four combinations of NPV and discount rate on a graph and connect them to form a smooth line. Observing this graph, you can figure out the discount rate at which NPV is equal to zero. Nowadays, most companies use special programmes on computers and hire financial managers to conduct such calculations on a large scale.

The Internal Rate of Return Rule

It is important to understand that IRR and opportunity cost of capital are very different measurement tools. IRR measures profitability and thus depends only on the amount and timing of project cash flows. While on the other hand, the opportunity cost of capital forms the standard of profitability which is used to calculate the worth of any project. It is the expected rate of return offered by other assets with the same risks as the project being evaluated.

The IRR rule states that we must accept an investment project if the opportunity cost of capital is less than the internal rate of return. At any discount rate, if the project has a positive NPV when discounted at the opportunity cost of capital, it implies that the opportunity cost of capital was less than the calculated IRR. If the opportunity cost is equal to the IRR, the project has zero NPV and if the opportunity cost exceeds IRR, then the project has a negative NPV. NPV is a smoothly declining function of discount rate which reflects whether or not the project has a positive NPV. The goal of IRR is to find out the rate of discount, which makes the present value of the sum of annual nominal cash inflows equal to the initial net cash outlay for the investment.

Advantages of IRR

Time Value of Money

The internal rate of return considers the time value of money when evaluating a project. One can measure IRR by calculating the interest rate at which the PV of future cash flows is equal to the capital investment required.

Simplicity

IRR is very easy to calculate and interpret as compared to other measurements and is often used as the primary measure of project attractiveness. If the IRR exceeds the cost of capital, then accept the project, but not otherwise.

Hurdle Rate Is Not Required

The hurdle rate is a difficult and subjective thing to decide. In IRR, there is no requirement to find out the IRR hurdle rate or the required rate of return. IRR does not depend on the hurdle rate thus reducing the false determination of the hurdle rate.

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IRR is very easy to calculate and interpret as compared to other measurements and is often used as the primary measure of project attractiveness.

The Limitations of IRR

Lending and Borrowing Pitfall

All cash-flow streams do not have NPV as a declining function of the discount rate. In some cases, we lend money at a discount rate by paying out while in other cases we receive or borrow money at some discount rate. When we lend money we want a higher discount rate while when we borrow money we want a low rate of return. In such cases where NPV increases with an increase in the discount rate, the IRR rule does not apply.

More than one rate of return

Sometimes there are two discount rates at which the net present value is equal to zero. This happens when NPV initially increases with an increase in the discount rate and then declines with a further increase in the discount rate. There can be several internal rates of return for a project if there are changes in signs of the cash flows.

For instance, decommissioning and clean-up costs can be very large like removing offshore oil platforms may cost almost a billion dollars. These make cash flows go negative. Sometimes hotels need to get a facelift, machines may need repair or replacement, etc leading to negative cash flows. In such cases again, the IRR proves to be invalid.

More than one opportunity cost of capital

When we discount, we discount the first payoff at the opportunity cost of capital for one year, the second payoff at the opportunity cost of capital for two years and so on and so forth. According to the IRR rule, we accept a project if the IRR is greater than the opportunity cost of capital. But this rule fails to apply when there are more than one opportunity costs. It leads to a lot of complexities in calculations leading to a failure in the calculation system.

Mutually Exclusive Projects and IRR

Companies often have to choose between several alternative ways of doing the same job or using the same facilities and thus need to choose between mutually exclusive projects. Often it happens that suppose there are two projects X and Y, X involves a manually controlled machine while Y incorporates a higher level of technology in addition to labour. Both may seem like good investments but suppose X has a higher NPV compared to Y while Y has a higher IRR than X. Which do you prefer? Thus IRR fails to comply here. However, we can use IRR on incremental investment flows and check if that IRR is more than the opportunity cost. IRR is also unreliable in ranking projects offering different patterns of cash flow over time.

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Strategising Business Strategies for Successful Entrepreneurs

Smruthi Krishnan — Wed, 14 Apr 2021 04:35:08 +0000

Whether you are a small-scale entrepreneur or a start-up founder, business strategies form the very crux of your ventures whilst building the foundation of success (sometimes failures too). They are basically the course of actions or decisions which help entrepreneurs in achieving specific business objectives. To ensure a competitive advantage in the market, to plan ahead expansion and scaling of the venture, to generate revenue and customer satisfaction thus achieving the end goals of business, every company has a master plan or business strategy that makes them stand out from the rest of the companies and paves the path of success for them.

What are Business Strategies?

Just like an artist before painting a picture draws an outline and decides the colour palette he wishes to work with, in businesses, strategies act as an outline sketch that provide direction and image of the venture. It builds a rough idea of the intent and action which is then orchestrated or carefully painted by the company in order to achieve an effective workspace that optimises opportunities, mobilizes resources, reaches a position of advantage, meets threats and challenges with a proper plan, directs efforts and behaviours in lines of that of the company and commands control over unprecedented situations.

As it is often said, if you fail to plan, you plan to fail. A business strategy is basically a plan that involves moves and actions that a business uses to attract customers and strengthen its performance while achieving their organisational goals. It gives the business an outline as to how it should function in order to reach its desired ends. Most strategies occur within the top tier of management so as to provide a base framework for discovery and development in order to analyse and optimise opportunities. Another main focal point of business strategy is to help meet potential as well as unprecedented threats and counterbalance weakness.

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Just like an artist before painting a picture draws an outline and decides the colour palette he wishes to work with, in businesses, strategies act as an outline sketch that provide direction and image of the venture.

Importance of Business Strategies

You cannot achieve your dreams without a plan to achieve them. After you set your business objectives, you must focus on strategies to achieve them lest your objectives end up being a dream. When you are investing large amounts of money into your ventures, it is necessary to implement smart business strategies that up your game and help you become successful.

Choose strategies that make you stand out from the crowd and increase your revenue traction. With more and more people venturing into the business landscape, it is becoming increasingly difficult to come up with newer and better strategies. However, we still have not reached saturation in the strategy market. There are several reasons why business strategies are important.

Knowing your Strengths and Weaknesses

While formulating your business strategy, you can focus more on your strengths and weaknesses. This helps you optimise in areas where you excel and figure out ways to cope with your weaknesses so that your chances of success increase.

Planning

Business strategy is a part of a business plan. Business plans help you analyse and set your goals and objectives while strategies will help you figure out how to achieve the said objectives.

Efficiency and Effectiveness

Strategies help you allocate how much resource should be allocated at every step, assigns jobs to every person in the company, and ensures smooth functioning of the business. This increases efficiency and effectiveness of the business operations especially in the long run.

Competitive Advantage

As mentioned above, business strategies focus on optimising and playing on a company’s strengths thus giving them a competitive advantage that helps them stand out from other ventures. This also helps in brand marketing and advertising giving a unique recognition to the brand and creating traction amongst consumers for the brand.

Levels of Business Strategy

Although it may seem like there is only one solid set in stone strategy for the entire business, there are multiple tiers at which multiple strategies work simultaneously to run the business. Business strategies usually pan out to three different levels:

Business level strategy:

Strategies related to any particular business are known as business-level strategies. They are developed by the general managers who transform the company vision into realistic strategies. These act as the map to success for the entire business. These strategies are unit specific strategies which differ for different units of the business.

Corporate level strategy:

These are long-range, action-oriented, integrated and comprehensive plans that are strategised by those sitting in the top tiers of management. The corporate level is the highest and most broad level of the business strategy. They set the mission, vision, and corporate objectives for everyone. They focus mainly on ascertaining business lines, expanding, scaling, growth perspectives including takeovers and mergers, diversification, acquisitions, integration, investments and more.

Functional level strategy:

These strategies are developed by the first-line managers or supervisors, and help in the decision making at the operational level. They focus on day-to-day business issues around certain functional areas like marketing, production, human resource, research and development and finances. They are needed to deliver unit level and corporate level strategies. These strategies also help maintain relationships between different departments and help the business move forward as a whole.

Key Components of a Business Strategy

Strategies answer all the what, why, whose, when, where and how of reaching your business goal. The key components of any business strategy include:

Vision and Business Objective

As we have discussed before, the main duty of any strategy is to help achieve a business goal or objective. They set the stepping stones that lead up to fulfilment of the company goals with a clear vision or blueprint that tells us what and how things need to be done and by whom.

Core Values

Business strategies are the perfect embodiment of a company’s core value. They reflect all the dos and don’ts of the business and highlight the morals and visions of the business.

SWOT

A SWOT (Strengths, Weaknesses, Opportunities and Threats) analysis is a rundown of the company’s current situation. It forms a core component of a business strategy as it highlights the strengths and opportunities which the company can optimize on and the weaknesses and threats which the company should tread carefully by.

Operational Tactics

Unit and functional business strategies delve deeper into how the work needs to be done such that the results obtained and the process involved take place in the most effective and efficient manner. Since everyone knows what exactly needs to be done and how it should be done, it saves a lot of time and effort.

Resource Procurement and Allocation

Business strategies also imply from where resources will be procured from across the landscape and how these resources will be distributed for various functions between different departments. And who will look into procurement, allocation and distribution of said resources.

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Business strategies are the perfect embodiment of a company’s core value. They reflect all the dos and don'ts of the business and highlight the morals and visions of the business.

Business strategy examples

1. Cross-sell more products

Some organizations focus on selling more products to the same customer. They increase the amount of product sold per customer thus increasing the average cart size. This increases profitability without looking for new customers.

3. Grow sales from new products

Investing in research and development in order to constantly innovate, even with your most successful products will up your business sales in more ways than one.

4. Improve customer service

Another good business strategy is delivering quality customer service. You can build a strong reputation for having exceptional customer service like online support or a more effective call center.

5. Cornering a young market

Some large companies are buying out or merging competitors to corner a young market where they had no strong position before whilst retaining old customers. This is a common strategy used by Fortune 500 companies to gain leverage in a rapidly growing market.

6. Product differentiation

B2C businesses differentiate their products by highlighting the fact that they have superior technology, features, pricing or styling. This is called product differentiation which was used by Apple to differentiate its smartphone operating system iOS by making it really simple as compared to Android.

7. Pricing strategies

Pricing strategies involve either very high prices to channel exclusivity of product or very low prices to increase traction. With low prices, high volumes of sales are required to earn profits. High prices maintain exclusivity of the product, keeping them from ordinary customers whilst retaining a large profit margin per product.

8.Buying the Competition

You can buy your competition or pioneers in technology instead of creating one on your own and competing. Facebook’s buy the competition strategy has led to notable acquisitions Instagram, WhatsApp, Oculus, etc which increased its reach and user base.

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Analysing Viewership Revenue of IPL: How will 2021 fare?

Smruthi Krishnan — Mon, 12 Apr 2021 00:35:04 +0000

The IPL is one of the most-attended cricket leagues in the world and was ranked sixth by average attendance among all sports leagues in 2014. The IPL was the first sporting event in the world to be broadcast live on YouTube. According to BCCI, the 2015 IPL season contributed ₹11.5 billion to the GDP of the Indian economy.

Broadcasting in IPL via SONY

The IPL’s broadcast rights were earlier given to Sony Pictures Networks and World Sport Group, under a ten-year contract valued at US$1.03 billion. In the 2016 season, Sony MAX, Sony SIX, and Sony ESPN served as the domestic broadcasters of the IPL

Acquiring the IPL, a major television property within India turned Sony MAX into the most-watched television channel during the tournament. Their annual advertising revenue surpassed ₹12 billion by 2016. In the 2016 season, Sony’s broadcasts achieved just over 1 billion impressions jumping to 1.25 billion in 2017.

Star and Disney+ Hotstar

In 2017, Star India acquired the global media rights to the IPL under a five-year contract beginning in 2018 at ₹163.475 billion making it the most expensive broadcast rights deal in the history of cricket. The IPL sold the rights in packages for domestic television, domestic digital, and international rights.

Star tried to increase viewership targeting core cricket audiences by broadcasting at least two hours of IPL-related programming daily from January until the start of the season including televised announcements of player retention selections and new team captains, player auction, pre- and post-auction reactions and analysis. This increased viewership six-fold to 46.5 million. They also focused on the behind-the-scenes coverage of the IPL’s teams and expert analysis post matches.

Star broadcasts IPL matches live online in India via its over-the-top video streaming platform Disney+ Hotstar. Matches are also available on Jio TV and Airtel TV apps on smartphones. International streaming viewership on Disney+ Hotstar saw records, exceeding 10 million concurrent viewers multiple times in 2019 especially with the 2019 final peaking at 18.6 million concurrent streaming viewers.

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In 2017, Star India acquired the global media rights to the IPL under a five-year contract beginning in 2018 at ₹163.475 billion making it the most expensive broadcast rights deal in the history of cricket.

Previous Year Revenue from Viewership and 2021 Estimates

The Board for Control of Cricket in India (BCCI) earned Rs. 4000 crore revenue in IPL 2020 despite the pandemic and witnessed a total of 25 per cent increase in the viewership from the last year. It was a cash-rich league conducted in UAE due to COVID-19 protocol which for obvious reasons had no gate revenue. The majority of the revenue stream was from broadcast viewerships and the league was a successful one.

With the whole season shifting to broadcast revenue, TV ads were a major contributor to the revenue. Star India raised around Rs 2,600 crore in advertising revenue from TV and digital in 2020. According to BARC, last season saw a 23 percent growth in viewing minutes. It is estimated to increase further this year which will lead to a hike in ad rates ad advertisers know they have the viewership. IPL 2020 became the first sports tournament to cross the 400 billion viewing minutes as compared to 326 billion it had recorded in 2019.

With the country dealing with the post-covid normal, albeit a continual surge in COVID cases, IPL 2021 continues to be conducted in the new normal way. As states across the nation are going into lockdown and night curfews, going to the stadium to watch the match isn’t an option for the time being. The viewership and live streams is expected to increase given past statistics and will hopefully cross 400 billion viewing minutes once again and set a new record. The increase in viewership due to nationwide COVID protocol is clearly paving the path for an increase in revenue from broadcasting and advertising in the 14th edition of the Indian Premier League. The numbers are much less but fingers crossed as it’s a huge tournament, the BCCI did it successfully in Dubai and hopefully, we can do it this time as well.

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Return on Investment: What Entrepreneurs Must Know

Smruthi Krishnan — Wed, 07 Apr 2021 04:35:05 +0000

Return on Investments, Internal Rate of Return, Net Present Value and other cash flow measures are metrics used to evaluate and rank different investment alternatives based on how attractive each opportunity is. Return on investment (ROI) is popularly used across the business landscape as a metric to measure the probability of gaining a return from an investment.

Although it is a ratio, it’s measured as a percentage that compares the gain or loss from an investment relative to its cost. It is used to measure the probable return from stand-alone investments and comparing returns from different investments.

Return on Investment is used to measure how profitable a stock investment or real estate investment can be and also helps decide whether or not to invest in a particular business. Due to the relative ease of calculating and understanding ROI, it has become a universal measure of profitability in the entrepreneurial world and is used as a set standard measure across countries and companies.

Factors Affecting Return on Investment

Diversified Investment Portfolio:

The overall return of any investment portfolio depends on how diversified the asset mix is. The more the risk, the more the volatility and return potential of the investment portfolio. For instance, stocks are riskier than bonds and thus the rate of return on stocks is more than bonds. But you cannot only invest in stocks as during high volatility, the economy crashes down. When you invest in high-quality bonds, you can have more stable returns that are easy to predict.

Business Strategy:

The business strategies and operations of a business will impact the returns on investment. It depends on how a company optimises on the opportunities they get and deal with market fluctuations and competitions. This will include expansion into new areas, innovating and developing better products, etc. Companies that lose market share and miss earnings expectations almost always underperform the market.

Macroeconomic conditions:

Investment rates of return depend on macroeconomic situations in a country. As more people have jobs, they have more income and tend to spend more. This leads to more sales, profits and investments in terms of capital and resources. Rapid growth leads to higher interest rates making credit more costly and reducing spending and investments. consumer spending and business investments. On the other hand, slowdowns reduce employment, profitability and stock prices. This in turn improves bond prices as investors shift to bonds due to risk averseness.

Fiscal policy:

Policies, regulations and political stability affect investment rates of return. Large fiscal deficits lead to higher borrowing costs for businesses. A stringent regulatory process affects business investments negatively especially in sectors like energy and resources. Political stability leads to investor confidence and increases investment return potentials. Investors will avoid countries with unstable governments or war-prone areas.

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Although it is a ratio, it's measured as a percentage that compares the gain or loss from an investment relative to its cost. It is used to measure the probable return from stand-alone investments and comparing returns from different investments.

Importance of ROI in business

Closely monitoring the ROI whilst spending wisely is the sign of a smart business that helps them survive in the long run. When you do not see the optimal return on investments in your venture, the smart move is to let it go and invest your funds elsewhere. If you continue to spend it in the same venture, it will lead to losses and debt traps as your business crashes down.

ROI varies with variation in industry. With factors like competition, technological changes and shift in preferences, ROI of industries fluctuate over time. In 2020, technology companies such as Apple Inc. Microsoft Corp. and Amzon.com Inc. generated annual returns well above 10%. On the other hand, energy companies and utilities generated much lower ROIs. Some companies crashed down while some faced losses year-over-year.

What is considered as an optimal ROI?

Return on investment is productive when companies spend money and invest in equipment and capital. Return on investments in terms of sales requires investment in marketing areas. Returns from investing in a new building will have a stark difference from returns from spending on your online marketing like website optimization. Usually, double-digit ROI is healthy during the initial periods of operation and if you get high percentages of ROI then it is always better to optimize and work towards the amplification of such effects. Make smart decisions when it comes to spending money and investing in new areas.

Return on Investment Analysis

Return on Investment analysis is a tool used by analysts to calculate the profitability of any particular investment and also to compare different types of investments. Benefits from an investment are usually called returns as returns can be positive as well as negative whereas profits are only positive. Positive returns on investment mean that investors have gained while in case of negative ROI they incur losses.

ROI analysis can be done in two ways.

By comparing the ROI between periods or companies or with the industry average. For instance, if Company X has an ROI of 20% and Company Y is of the same size as X and works in the same sector having an ROI of 15%, then clearly Company X is better amongst the two.

By breaking down ROI into parts and individually analysing these components. Let’s suppose that the ROI for a company (Net Income/Total Assets) is made up of two components – the asset turnover and the company’s profit margin. Looking at these two components separately, the first part (Income/Sales) shows the net profit margin. The other part (Sales/Total Assets) reflects Asset Turnover. By analysing these two parts individually, you can see which causes an issue with the company’s ROI. This method is also called Dupont.

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Return on Investment analysis is a tool used by analysts to calculate the profitability of any particular investment and also to compare different types of investments.

Interpreting the Return on Investment (ROI)

ROI is usually represented in percentages in order to make it easier. It includes net return in the numerator as returns can be positive or negative. When ROI calculations give positive results, net returns are in the black as total returns exceed total costs. While on the other hand when ROI calculations yield negative figures, net returns are in the red because total costs exceed total returns or there is a loss. To maintain a high level of accuracy, total returns and total costs should be considered.

Advantages of Return on Investment (ROI)

ROI is easy to calculate and understand making it a standard and universal measure of profitability. It emphasizes on financial gains while calculating returns and ignores social and environmental benefits. ROI analysis helps investors in comparing various investment opportunities.

You can also use ROI to compare returns of current and previous periods to analyse and change your portfolio accordingly. ROI is also used to observe competitiveness in the market. Numbers or parameters required to calculate the ROI are easily available in the financial statements in the traditional accounting system. ROI analysis helps understand pain points and resolve issues quickly. ROIs help set simple targets for both short-term and long-term goals and measure whether or not you are achieving those benchmarks quickly and easily. ROI keeps your company on track by measuring whether your business is profiting above or below its average.

Disadvantages of Return on Investment (ROI)

ROI does not take into account the holding period of an investment which creates issues whilst comparing investment alternatives. A company’s cash flow is not directly reflected in their ROI, so their financial health may not always be measured accurately using ROI alone. Also, ROI only measures the financial success of a project. Investing in new technology may lead to negative ROI but might increase retention rates and happiness levels of employees. ROI does not adjust for risk. However, investment returns have a direct correlation with risk, the more the expected returns, the greater the possible risk.

If an investor considers the only ROI without evaluating associated risk, the eventual outcome of the investment may turn out very differently. ROI figures can be exaggerated if all the expected costs are not included in the calculation. If companies calculate the ROI of all investments without focusing on the value the portfolio or the company is offering, good investment opportunities can be missed.

Predicting ROI may seem like a piece of cake but nobody can see the future. Usually, only a well-thought-out investment will see positive returns. Do not blindly invest without conducting proper research and analysis. To read about more such concepts, check out our articles under DU Academy.

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Fixed Costs 101 for Entrepreneurs

Smruthi Krishnan — Fri, 02 Apr 2021 04:30:46 +0000

The total cost of production includes both fixed and variable costs. It is defined as the total expenditures incurred in production to purchase factor inputs including labour, land and capital that are needed to manufacture a product. Cost refers to the total cost incurred by a business to produce a specific quantity of a product or offer a service. These expenditures may include any kind of factor inputs like raw materials, human resources, capital machines, etc. For instance, production costs for baking a loaf of bread will include expenses like a microwave oven, raw wheat, sugar, baking powder, baker, and mass-producing the bread will require a place like a restaurant, bakery, etc. In the case of companies that offer services, they will require costs of setting up an office, material costs of setting up the services, payment to people who deliver the services and costs of delivering the services.

Types of Costs of Production

Every business incurs costs and receives revenue. A business runs only if the revenue or benefits of running the business is more than the costs incurred. In other words, a business is profitable only when costs are less than revenue. During the manufacturing process, a business will incur different types of costs depending on the product or service they offer. The following are the type of costs a normal business might occur regularly:

Fixed costs

Fixed costs are costs that do not change with the amount of output produced. In other words, fixed costs remain constant even if the company produces zero output or maximum output. A bakery must pay its rent irrespective of the number of goods it produces. They will have to pay the same amount to purchase an oven and fridge even if the amount of goods they produce fluctuates over time. It is a fixed cost. Salaries paid to employees are also fixed costs. Fixed costs are fixed in the short-term. They become variable after a period of time depending upon the business.

Variable costs

Variable costs are costs that change with the changes in the level of production. Variable costs increase with the increase in production and vice versa. If the production is zero, then no variable costs are incurred. In a bakery, variable costs include raw materials like sugar, wheat, cocoa powder etc. on the process and direct labour costs. If for instance, it costs Rs. 20 per pastry produced, then the total variable cost incurred by the bakery to produce 100 such pastries would be Rs. 2000.

Total cost

Total cost as mentioned before includes both variable and fixed costs. It takes into account all the costs incurred in the production process. For the bakery example, the total cost would include the cost incurred in buying the microwave oven, chairs, tables, renting the place and the amount spent on buying ingredients. If the fixed cost was Rs. 10,000 and the variable cost for producing 100 units of pastries was Rs. 2000 then the total cost of producing 100 pastries will be Rs. 12,000.

Average cost

The average cost is defined as the total cost of production divided by the number of units produced. You can also calculate it by adding up the average variable costs and the average fixed costs. Average costs are used to decide product pricings for revenue or profit maximisation. The average cost per unit should always be minimised by the business so they can increase profit margins without raising the costs of production.

Marginal cost

Marginal cost is the expenditure incurred in producing one additional unit of output. It reflects the increase in total cost due to an increase in production by one unit. As fixed costs remain unchanged irrespective of the level of production. So marginal cost can also be defined as the increase in variable cost due to an additional unit of the product being manufactured. If the company wants to increase production capacity, it will compare the marginal cost with the marginal revenue obtained by producing an additional unit. If marginal costs are more than the marginal revenue, the firm won’t go ahead with the production. Marginal costs are affected by various factors like price discrimination, externalities, information asymmetry, and transaction costs.

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Fixed costs are usually recurring, i.e you have to pay them again and again at certain intervals like interest or rents being paid per month.

More About Fixed Cost :

Fixed costs are considered an entry barrier for new entrepreneurs. In accounting and economics, fixed costs are expenses incurred by businesses that are independent of the level of goods or services produced by the business. They are also known as indirect costs or overhead costs. Fixed costs are usually recurring, i.e you have to pay them again and again at certain intervals like interest or rents being paid per month. Variable costs on the other hand depend on the quantity of product produced and change accordingly. You can predict fixed costs at the beginning of the year but you cannot predict variable costs as they depend on production levels.

For instance, in our bakery example, the monthly rent and phone line are fixed costs, utility bills are also fixed costs. These costs will be incurred irrespective of how much bread is produced and sold. Wage, wheat, sugar, electricity on the other hand are variable costs. With the increase in production, you will need more workers and more raw materials and your variable cost would increase accordingly.

Difference between Fixed Cost and Variable Cost:

Example for Fixed vs. Variable Costs incurred by a bakery

Depreciation of oven: Variable cost

Cost of shipping finished goods to customers: Variable cost

Wheat used in manufacturing bread: Variable cost

Baker’s and bakery manager’s salary: Variable cost

Electricity used in manufacturing: Variable cost

Packing supplies for shipping products: Variable cost

Advertising costs: Fixed cost

Insurance: Fixed Cost

Fixed Costs become Variable over time:

Fixed costs are not fixed permanently. They can and mostly will change over time. However, by contractual obligations, they are fixed over months or years. A company may have unpredictable expenses independent of production like renting a warehouse which is fixed over some time of contract. But there are no fixed costs in the long run. This is because all the short-run fixed inputs become variable in the long run.

Machines, buildings, rent etc cannot be changed in the short run based on production and therefore become fixed costs but over a longer period depending on the business, these investments can become variable like increase in the number of machinery, buildings, etc based on your overall level of production. Discretionary costs fixed costs are fixed annually like advertising, insurance premia, machine maintenance, and research & development expenditures.

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Machines, buildings, rent etc cannot be changed in the short run based on production and therefore become fixed costs but over a longer period depending on the business, these investments can become variable.

Fixed Costs and Business Planning:

Capital can be the fixed price for buying a warehouse for production machines and it can be a total salary paid to a particular quantity of labour. Based on the market and product, many things are covered under fixed costs and variable costs distinctively. However, if short term fixed costs are too high, firms may not enter the market. Thus these firms help a firm determine if they can enter a market.

In business planning and management accounting, fixed costs, variable costs are different as compared to their usage in economics. In accounting, fixed costs broadly include almost all expenses that are not included in the cost of goods sold, and variable costs are those captured in costs of goods sold. In order to create a balance between the two approaches, just assume that the accounting period is equal to the period in which fixed costs are independent of production. In reality, however, this equivalence does not always hold.

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