How Does a Company’s Decision to Focus on Fixed Rather Than Variable Cost Impact Income Statement?
Essay by knsmith21996 • June 11, 2018 • Course Note • 732 Words (3 Pages) • 864 Views
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- How does a company’s decision to focus on fixed rather than variable cost impact income statement?
- Variable costs vary more in the short term and receive more managerial attention than the fixed costs. They can adjust the variable cost easier in the short term than trying to help the bottom line by adjusting fixed costs. COGS is mostly comprised of variable costs and operating expenses are mostly comprised of fixed costs. If the company is focusing on gross profit, they will monitor the COGS (variable costs).
- Variable costs will be most likely purchased on credit which would increase accounts payable on the balance sheet. Fixed costs in the form of labor costs might show up as payroll liabilities on a balance sheet.
- If they improve the bottom line on the income statement by focusing on lowering variable or fixed costs, retained earnings will be higher on the balance sheet.
- During high times, the person with more fixed costs wins and during low times, the person with more variable costs will win.
- What is burn rate and why is it important?
- Burn rate is normally used to describe the rate at which a new company is spending its venture capital to finance overhead before generating positive cash flow from operations. It is a measure of negative cash flow. Burn rate is usually quoted in terms of cash spent per month.
- This is important because when starting a company, you have to make sure you have enough capital to sustain the amount of cash you are spending each month. This is often the main reason startups fail.
- Lower salaries and increase bonuses for start up company so it has more money.
- Really need to nail IPO because need to make sure have enough equity.
- 2nd time asking for money from investors means you do not have it together
- How to improve bottom line and manage the income statement/balance sheet during boom, bust, and static economic cycle?
- During a boom, you will probably have decent cash and possibly higher retained earnings that you would reinvest in the company. For example, spending cash on a new machine that only takes $1,000 a month rather than $2,000 a month running the old machine, lowers the fixed costs which will in turn improve the bottom line.
- During a bust, high fixed costs will put pressure on the profit margins. These fixed cost cannot be adjusted right away to account for the lower production during the bust. You would want to focus on lowering variable costs since fixed costs are hard to lower. For example, layoffs are common during a bust to try and reduce costs.
- During a bust, you may want to refinance to lower interest rates. This would decrease the interest expense and improve the bottom line.
- During a bust, managers may need to focus on the accounts receivables more so they can receive more of their money to then pay off their accounts payable.
- During a bust, profitable companies can overtake companies that are struggling through the bust. The companies struggling would be more likely to sell the business for less money than during a boom.
- During boom, basic question, double down or look at risk management?
- During bust, have to decide whether going to focus more on revenue or reduce cost.
- Boom and bust have own opportunity and threats. Need strategic making
- Some of the decisions depend on what industry you are in on what to do during these times.
- What do we need to know and understand about accrual versus cash accounting?
- The difference between accrual and cash accounting is when revenue and expenses are recorded. With cash, you generally recognize revenues and expenses later than you would with accrual. The most common method is accrual because it is assumed to provide better information to owners on the results of operations and better information to those who use information from financial reports in makings decisions.
- Using the cash basis, expenses are recognized when cash is expended and revenue is recognized when cash is received.
- Using the accrual basis, accountants may recognize revenues when delivery of product or service has occurred even if cash has not yet been received. Also, expenses will be measured and recognized in the same accounting period as the revenues to which they relate.
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