Advertising Effectiveness
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Advertising Effectiveness
Advertising Effectiveness
Advertising Effectiveness
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Advertising Effectiveness
On the other hand, advertising denotes a specific attempt to popularize a specific product or service at a certain cost. It is a method of publicity. It always intentional openly sponsored by the sponsor and involves certain cost and hence is paid for. It is a common form of non- personal communication about an organisation and or its products idea service etc. that is transmitted to a target audiences through a mass medium. In common parlance the term publicity and advertising are used anonymously.
What is Advertising :
The word advertising is derived from the Latin word viz, "advertero" "ad" meaning towards and "verto" meeting towards and "verto" meaning. "I turn" literally specific thing".
Simply stated advertising is the art "says green." Advertising is a general term for and all forms of publicity, from the cry of the street boy selling newspapers to the most celebrate attention attracts device. The object always is to bring to public notice some articles or service, to create a demand to stimulate buying and in general to bring logethel the man with something to sell and the man who has means or desires to buy".
Advertising has been defined by different experts. Some of the quoted definition are :
American marketing association has defined advertising as "any paid form of non personal presentation and promotion of ideas, goods or services by an identified sponsor. The medium used are print broad cast and direct.
Stanton deserves that "Advertising consists of all the activities involved in presenting to a group a non- personal, oral or visual openly, sponsored message regarding a product, service, or idea. This message called an advertisement is disseminated through one or more media and is paid for by the identified sponsor.
Advertising is any paid form of non – personal paid of presentation of ideas goods or services by an identified sponsor.
Advertising is a "non- personal paid message of commercial significance about a product, service or company made to a market by an identified sponsor.
In developing an advertising programme, one must always start by identifying the market needs and buyer motives and must make five major decisions commonly referred as 5M (mission, money message, media and measurement) of advertising.
Basic Features of Advertising
On the basis of various definitions it has certain basic features such as :
1. It is a mass non-personal communication.
2. It is a matter of record.
3. It persuades buyers to purchase the goods advertised.
4. It is a mass paid communication.
5. The communication media is diverse such as print (newspapers and magazines)
6. It is also called printed salesmanship because information is spread by means of the written and printed work and pictures so that people may be induced to act upon it.
Functions of Advertising
For many firms advertising is the dominant element of the promotional mix – particulars for those manufacturers who produce convenience goods such as detergent, non – prescription drugs, cosmetics, soft drinks and grocery products. Advertising is also used extensively by maters of automobiles, home appliances, etc, to introduce new product and new product features its uses its attributes, pt availability etc.
Advertising can also help to convince potential buyers that a firms product or service is superior to competitors product in make in quality, in price etc. it can create brand image and reduce the likelihood of brand switching even when competitors lower their prices or offer some attractive incentives.
Advertising is particularly effective in certain other spheres too such as :
i) When consumer awareness of products or service is at a minimum.
ii) When sales are increasing for all terms in an industry.
iii) When a product is new and incorporates technological advance not strong and.
iv) When primary buying motive exists.
It performance the following functions :
i) Promotion of sales
ii) Introduction of new product awareness.
iii) Mass production facilitation
iv) Carry out research
v) Education of people.
TYPES OF ADVERTISING
Broadly speaking, advertising may be classified into two categories viz., product and institutional advertising.
a) Product Advertising
The main purpose of such advertising is to inform and stimulate the market about the advertisers products of services and to sell these. Thus type of advertising usually promote specific, trended products in such a manner as to make the brands seam more desirable. It is used by business government organization and private non-business organizations to promote the uses features, images and benefits of their services and products. Product advertising is sub-divided into direct action and indirect action advertising, Direct action product advertising wages the buyer to take action at once, ice he seeks a quick response to the advertisement which may be to order the product by mail, or mailing a coupon, or he may promptly purchase in a retail store in response to prince reduction during clearance sale.
Product advertising is sub-divided into direct & indirect action advertising & product advertising aims at informing persons about what a products is what it does, how it is used and where it can be purchased. On the other hand selective advertising is made to meet the selective demand for a particular brand or type is product.
b) Institutional Advertising :
It is designed to create a proper attitude towards the sellers to build company image or goodwill rather than to sell specific product or service. Its purpose is to create a frame of mind and to implant feeling favourable to the advertisers company. Its assignment is to make friends for the institution or organization.
It is sub-divided into three categories : patronage, public, relations and public service institutional advertising.
i) In patronage institutional advertising the manufacturer tells his prospects and customer about himself his policies and lives personnel. The appeals to the patronage motivation of buyers. If successful, he convince buyers that his operation entitles him to the money spent by them.
ii) Public relations institutional advertising is used to create a favourable image of the firm among employees, stock-holders or the general public.
iii) Public service institutional advertising wages public support.
c) Other Types :
The other types are as follows :
i) Consumer advertising
ii) Comparative advertising
iii) Reminder advertising
iv) Reinforcement advertising
ADVERTISING OBJECTIVES
The long term objectives of advertising are broad and general, and concern the contribution advertising should make to the achievement of overall company objectives. Most companies regard advertisingly main objective as hat of proving support to personal selling and other forms of promotion. But advertising is a highly versatile communications tools and may therefore by used for achieving various short and long term objectives. Among these objectives are the following :
1. To do the entire selling job (as in mail order marketing).
2. To introduce a new product (by building brand awareness among potential buyers).
3. To force middlemen to handle the product (pull strategy).
4. To build brand preference 9by making it more difficult for middleman to sell substitutes).
5. To remind users to buy the product (retentive strategy).
6. To publicize some change in marketing strategy (e.g., a price change, a new model or an improvement in the product).
7. To provide rationalization (i.e. Socially acceptable excuses).
8. To combat or neutralize competitors advertising.
9. To improve the moral of dealers and/or sales people (by showing that the company is doing its share of promotion).
10. To acquaint buyers and prospects with the new uses of the product (to extend the PLC).
BENEFITS
The functions of advertisement, and that purpose its ethics, may be discussion below :
1. It leads to cheaper prices. "No advertiser could live in the highly competitive arena of modern business if his methods of selling were more costly than those of his rivals."
2. It acquaints the public with the features of the goods and advantages which buyers will enjoy.
3. It increases demand for commodities and this results in increased production. Advertising :
a) Creates and stimulates demand opens and expands the markets;
b) Creates goodwill which loads to an increase in sales volume;
c) Reduces marketing costs, particularly product selling costs.
d) Satisfied consumer demands by placing in the market what he needs.
4. It reduces distribution expenses in as much as it plays the part of thousands of salesman at a home. Information on a mass scale relieves the necessity of expenditure on sales promotion staff, and quicker and wider distribution leads to diminishing of the distribution costs.
5. It ensures the consumers better quality of goods. A good name is the breath of the life to an advertiser.
6. By paying the way for large scale production and increased industrialization, advertising contributes its quota to the profit of the companies the prosperity of the shareholder the uplifts of the wage earners and the solution of he unemployment problem.
7. It raises the standard of living of the general public by impelling it to use to articles of modern types which may add to his material well being. "Modern advertising has made the luxuries of yesterday the necessities of today ..................... It is a positive creative force in business. It makes two blades of grass grow in the business world where one grew before.
8. It establishes the goodwill of the concern for the test articles produced by it and in course of time they sell like not cakes consumer search for satisfaction of their needs when they purchase goods what they want from its beauty, superiority, economy, comfort, approval, popularity, power, safety, convenience, sexual gratification and so on. The manufactures therefore tries to improve this goodwill and reputation by knowing the buyer behaviour.
To sum up it may be said that advertising aims at committing the producers, educating the consumer, supplementing the salesman converting the producer and the dealer to eliminate the competitor, but above all it is a link between the produce and the consumer.
WHY & WHEN TO ADVERTISE
Advertising as a tool to marketing not only reaches those who buy , but also those whose opinions or authority is counted for example a manufacturer of marble tiles and building boards advertises not only to people who intend to build houses but also to architect and engineers. While the manufacturers of pharmaceuticals products advertise to doctors as well as to the general public. At time it is necessary for a manufacturer or a concern to advertise things which it does not sell but which when sold stimulates the sales of its own product. There are concerns like electric heaters, iron etc. because the use of these increases the demand for their products.
Advertising should be used only when it promises to bring good result more economically and efficiently as compared to other means of selling. There are goods for which much time and efforts are required in creating a demand by sending salesman to prospective buyers than by simply advertising them. In the early days of the cash register in America it was sold by specially trained salesman who called on the prospective users and had the difficult task of convincing them that they could no longer carry on with the old methods, and that they urgently needed a cash register. In our country certain publishers have found it less costly to sell their books by sending salesman from house to house among prospective buyers than to advertise them. In these two examples the cost of creating demand would be too high if attempted by advertising alone under such circumstances advertising is used to make the salesman acceptable to the people they call upon to increase the confidence of the public in the house. Naturals when there are good profits competitors will be attracted and they should be kicked out as and when sufficient capital is available by advertising on a large scale. Immediate result may not justify the increased expenditure but it will no doubt secure future sales.
DESIGNING ADVERTISING CAMPAIGN :
An advertising is an organized series of advertising messages. It has been defined as "a planned, co-ordinate series of promotional efforts built around a central theme and designed to reach a specified goals." In other words, it is an orderly planned effort consisting of related but self – contained and independent advertisements. The campaign may appear in one more media . it has single theme or keynote idea and a single objective or goal. Thus, "a unified theme of content provides psychological continuity throughout the campaign while visual and oral similarity provide physical continuity. In short run, all campaign want pre-determined psychological reaction in the long run, practically all campaigns have sales goal.
The series of advertisements used in the campaign must be integrated with the sales promotional efforts and with the activities of the sales force.
Campaign vary in length some may run only for a few days, other for weeks, yet other for a season or the entire year. Usually a range of 3 to 6 months includes many campaigns. Many factors influences campaign length such as competitors advertising media, policies, seasonal falls curves of the product involved, the size of the advertising funds, campaign objectives and the nature of the advertisers marketing programme.
OBJECTIVES OF CAMPAIGN
The advertising campaign, especially those connected with the consumers aims at achieving these objectives :
i) To announce a new product or improve product.
ii) To hold consumers patronage against intensified campaign use.
iii) To inform consumers about a new product use.
iv) To teach consumers how to use product.
v) To promote a contest or a premium offer.
vi) To establish a new trade regional, and
vii) To help solve a coca regional problem.
The institutional advertising campaign on the other hand, have these objectives.
i) To create a corporate personality or image.
ii) To build a company prestige.
iii) To keep the company name before the public.
iv) To emphasize company services and facilities.
v) To enable company salesman to see top executive consistently when making sales calls, and
vi) To increase friendliness and goodwill towards the company.
Developing the campaign programmes. The advertising campaigns are prepared by the advertising agencies, which work an behalf of their clients who manufacture product or service enterprises, which have services to sell. The word campaign is used because advertising agencies approach their task with a sum Blanca of military fanfare in which one frequently hears words like target audience logistics, zero in and tactics and strategy etc.
The account executive co-ordinates the work in a campaign. The creation of an advertising campaign starts with an exploration of consumers habits and psychology in relation to the product. This requires the services of statistical trained in survey techniques and of others trained in social psychology. Statisticians select samples for survey which are done by trained interviewers who visits individuals, included in the sample and ask question to find out about their taste and habits.
This inquiry often leads to a change in a familiar product. For instance bathing soap may come in several new colors or cigarette in a new packet or talcum powder in another size.
Such interviews are often quite essential to find out the appeal of advertising message for a product that would be most effective with consumers.
David Ogilvy describes a consumers survey to find out the most meaningful benefit in which women are interested when they buy a face cream. The largest preference as given to "Cleans deep into pores" followed in order of importance by prevent dryness, "is a complete beauty treatment, recommended by skin doctors" makes skin look younger' contains estrogen hormones, pasteurized for purity, prevent skin form aging, smooth our wrinkles Ogilvy concludes, form this voting come one of Helena Rubinstein's most successful face creams. We christened it deep cleanser, thus, building the winning form into name of the product.
After getting the data the account executive puts together the essential elements of his clients brief, interprets the research findings and draws up what he calls the "advertising strategy".
STAGE IN ADVERTISING CAMPAIGN
Several steps are required to developed an advertising campaign the number of stages and exact order in which they are carried out may vary according to an organisations resources, the nature of its product and the types of audiences to be reached. The major stages/step are :
1. Identifying and analyzing the advertising.
2. Defining advertising objects.
3. Creating the advertising platform.
4. Determining the advertising appropriation.
5. Selection media plan.
6. Creating the advertising message.
7. Evaluating the effectiveness of advertising.
8. Organizing of advertising campaign.
1. Identifying & Analyzing the Advertising target :
Under this step it is to decided as to whom is the firm trying to reach with the message. The advertising target is the group of people towards which advertisements are aimed at four this purpose complete information about the market target i.e. the location and geographical location of the people, the distribution of age, income, sex, educational level, and consumers attitudes regarding purchase and use both of the advertising product and competing products is needed with better knowledge of market target, effective advertising campaign can be developed on the other hand, if the advertising target is not properly identified and analyzed the campaign is does likely to be effective.
2. Determining the advertising objectives :
The objectives of advertisement must be specifically and clearly defined in measurable terms such as "to communicate specific qualities about a particulars product to gain a certain degree of penetration in a definite audience of a given size during a given period of time", increase sales by a certain percentage or increase the firms market shares."
The goals of advertising may be to :
i) Create a favourable company image by acquainting the public with the services offered available to the employees and its achievements.
ii) Create consumers or distributor awareness by encouraging requests providing information about the types of products sold; providing information about the benefits to be gained from use of the company's products or services; and indicating how product (or services) can be used;
iii) Encourage immediate sales by encouraging potential purchasers through special sales contests, getting recommendation of professional people about company's products etc.
iv) It secures action by the reader through associating ideas, repetition of the same name in different contexts, immediate action appeal.
3. Creating the Advertising platform :
An advertising platform consists of the basic issues or selling points that an advertiser wishes to include in the advertising campaign. A single advertisement in an advertising campaign may contain one or more issues in the platform. A motorcycle producers advertising platform should contain issues which are of importance to consumers filling and such issues also be those which the competitive product do not posses.
4. Determining the Advertising Appropriation:
The advertising appropriation is the total amount of money which marketer allocates. For advertising for a specific time period. Determining the campaign budget involves estimating now much it will cost to achieve the campaigns objectives. If the campaign objectives are profit relating and stated quantitatively, then the amount of the campaign budget is determined by estimating the proposed campaigns effectiveness in attaining them. If campaigns object is to build a particular type of company image, then there is little basis for predicting either the campaigns effectiveness or determining the budget required.
5. Selecting the Media :
Media selection is an important since it costs time space and money various factors influence this selection, the most fundamental being the nature of the target market segment, the type of the product and the cost involved. The distinctive characteristics of various media are also important. Therefore management should focus its attention on media compatibility with advertising objectives.
6. Creating the Advertising Messages :
This is an important stage of advertising campaign. The contents of the message has to be very carefully drafted in the advertisement. Characteristics of person in the advertising target influence the message content and form. An advertisers must use words, symbols and illustration that are meaningful, familiar and attractive to those persons. The type of media also influence the content and form of the message.
7. Evaluating the Effectiveness of Advertising :
The effectiveness of advertising is measured for a variety of reasons :
a) To determine whether a campaign accomplished its advertising objects.
b) To evaluate the relative effectiveness of several advertisements to ascertain which copy, illustrations or layout is best.
c) To determine the strengths and weaknesses of various media and media plans.
In other words, measuring advertising effectiveness is needed to determine whether proposed advertisement should be used and if they will be now they might be improved; and whether going campaign should be stopped, continued or changed. In accomplishing these purposes, pretests and post test are conducted. The former tests before exposing target consumers to advertisements and the letter after consumers have been exposed to advertisements and the letter after consumers have been exposed to advertisements.
For an effective advertising programme, the advertising manager requires a basic understanding of the medium that is going to carry it.
For effectively using advertising the management must test advertising to know which of the advertisement to know which of the advertisement have proved profitable and why as compared to others.
OBJECTIVES OF THE STUDY
Following are the objectives of the study:
1. To know the most effective media of advertisement
2. To find out the reasons for liking the advertisement of cold drinks.
3. To find out the most popular slogan of advertisement regarding cold drinks.
Research Methodology
Research:
Research is a procedure of logical and systematic application of the fundamentals of science to the general and overall questions of a study and scientific technique which provide precise tools, specific procedure and technical rather than philosophical means for getting and ordering the data prior to their logical analysis and manipulation. Different type of research designs is available depending upon the nature of research project, availability of able manpower and circumstances.
Methodology
1. Research Design: The research design is the blueprint for the fulfillment of objectives and answering questions. It is a master plan specifying the method and procedures for collecting and analyzing needed information.
o Descriptive Research is used in this study as the main aim is to describe characteristics of the phenomenon or a situation.
2. Data Collection Methods: The source of data includes primary and secondary data sources.
Primary Sources: Primary data has been collected directly from sample respondents through questionnaire and with the help of interview.
Secondary Sources: Secondary data has been collected from standard textbooks, Newspapers, Magazines & Internet.
3. Research Instrument: Research instrument used for the primary data collection is Questionnaire.
4. Sample Design: Sample design is definite plan determine before any data is actually obtaining for a sample from a given population. The researcher must decide the way of selecting a sample. Samples can be either probability samples or non-probability samples.
RETAIL BANKING SERVICES: An Overview
Banking has come to occupy a pivotal position in a nation’s economy. According to the modern concept, banking is a business which not only deals with borrowings, lending and remittance of funds, but also an important instrument for fostering economic growth.
The Banking Regulation Act 1949, defines the term banking as “the accepting for the purpose of lending or investment of deposits of money from the public or otherwise and withdraw able by cheque, draft, order or otherwise.” Thus, the essentials of banking are:
(1) There should be acceptance of deposited.
(2) Deposits should be from the public.
(3) Deposits should be repayable on demand or expiry of a term or after a specified periods.
(4) The purpose of deposits should be lending or investment.
“Bank” is an institution which deals in money and credit. It buys money from depositors and sell to the borrowers. It is body of persons whether incorporated or not who carry on the business of banking. A bank may defined as a corporation or person which collects deposits from the public, repayable on demand and which supplies and facilitates all kinds of exchanges.
RETAIL BANKING
Retail banking means mobilizing deposit form individuals and providing loan facilities to them in the form of home loans, auto loans, credit cards, etc, is becoming popular. This used to be considered by the banks as a tough proposition because of the volume of operations involved. But during the last couple of years or so, banks seem to have realized that the only sustainable way to increase deposits is to look at small and middle class consumer retail deposit and not the price sensitive corporate depositors. With financial sector reforms gathering momentum, the banking system is facing increasing companies from non-banks and the capital market. More and more companies are tapping the capital market directly for finance. This is one of the main reasons for the banks to focus vigourously on the much ignored retail deposits. Another reason is the current liquidity the margins are 1 to 2 percent above the prime rate; in retail market they are 3to4 percent.
It is reported that Indian retail market has the potential to be second only to the USA. National Readership Survey 5puts Indian households with monthly of over Rs. 5000 at 4.5 million. According to the survey, the category of households with annual income of Rs. 2 lakhs and above is growing at the rate of 30 per cent per annum. No winder, banks with vision and insight are trying to woo this market through a series of innovative additions to their products, services, technology and marketing methods. Fixed and unfixed Deposits, (cluster deposits which can be broken into smaller units to help meet depositors’ overdraft without breaking up entirely), centralised database for ‘any branch banking’ (whereby the customer can access his account in any of the branches irrespective of where the account is maintained), room services (whereby the customers are visited at their residences offices to enable them to open their accounts), automatic teller machines, tele banking network, extended banking time, courier pickup for cheques and documents, etc are some of the privileges extended to the customers by the banks in are eagerness to cultivate the retail market. In short, in the bold new world of retail banking the customer is crowned as king.
RETAIL BANKING-A COOL OASIS
To bankers struggling through the shifting sands of corporate credit, retail banking looks like a cool oasis. Corporate Credit, retail banking looks like a cool oasis. Corporate customers rely less on commercial banks every day as other fund raising avenues present themselves. As this disintermediation takes place and competition shrinks margins, retail banking has gained an irresistible allure for banks because of its apparently higher margins and potential fir growth.
With their large branch networks, banks have secured sizeable deposits-23 percent of GDP. On the assets side, however, retail advances account for a mere seven per cent of total lending. The penetration of products like car loans or credit cards is very low. With very few focused multi-line banks, non banks are often significant players in retail lending, as HDFC is in house loans. Yet, many non-banks lack the minimum size to make the necessary investments and address the challenges of retail banking.
A large number of banks and non-banks have launched or relaunched retail products and are attempting to grow their share of the personal financial services market. Even the term lending institutions have decided that they need to go retail to raise funds. Many organization like ICICI are betting that a large part of their future growth will come from retail customers.
Retail banking is much more than as opportunity to addressing dwindling margins. It is an imperative to preserve profits and market positions. Customers now have many more personal financial options, a growing credit culture, a willingness to switch between financial services providers, and a demand for lower interest rates. As they witness these trends, banks realize that they cannot remain passive. The new private sector banks are making inroads in the markets they serve, while competition from non-banks is growing. In respect, older institutions need to revamp their distribution capabilities, customer management capabilities, operating culture, compensation system and operations processing.
WEB IMPACT ON BANKS RETAIL REVENUES:
For all those gurus who’ve been predicting that the net will end the business of said banks, here’s a shocker.
Even in the SILICON valley-driven USA, Internet is not expected to have a major impact in banks’ retail revenues.
The reason: the absence of a convenient alternative at present to using cash.
According to a report by moody’s Investors service, at least in the intermediate term, the internet is not expected to impact large US banks’ core profitability or competitive position.
This is despite the despite business being the simple-most important profit source for most American retail banks.
The core retail banking business of deposit taking will be sheltered form web-based competitors and margin shrinkage on this business.
Need for convenient access to physical locations coupled with the advantages of multiple delivery channels like branch, ATM, telephone and computers, consumers need to leave money in transactional accounts; customer inertia and the relatively limited cost savings available to consumers from net banking, are cited as the main factors supporting its view.
The moody’s report, however, cautions that other consumer business such as residential mortgages, auto loans and credit cards may be more vulnerable to web-based competitors.
However, most US banks have thin margins or low market shares in these businesses mitigating this impact, says the report made available to the Economic Times.
The rating agency is skeptical of banks ability to generate substantial incremental revenues from cross-selling financial products to existing customers via the net.
Banks have to maintain a comprehensive and effective web based capability to maintain their competitive position, cautions moody’s.
The need for customers to take frequent physical receipts, make convenient physical receipts, make convenient physical delivery of cheques using ATMs, inhibition towards paying ATM charges for using another bank’s ATM network by the consumer and time consuming, difficult and disruptive nature of switching accounts also contribute to the ‘stickiness’ of retail deposits.
With low bank fees for individual transactions and relatively small bank deposits, the opportunity cost in terms of interest income for customers is not material where the deposits are not large.
Banks offer convenience and choice and the web-based channels of banks have reported rapid growth in the number of customers by retaining current customers.
According to moody’s a survey indicated that 35 per cent of Internet banking customer disconnect because they don’t find it convenient.
Customers prefer to use a variety of channels to conduct their banking which is why it remains to be seen whether a business model based solely on internet banking will generate adequate returns and sustain long term competition against conventional banking systems.
The advent of the internet could, however have a powerful effect on banks acquisition strategies by creating uncertainty about the value of purchasing large branch networks, the study says.
For some banks, however, the Internet could facilitate an increase in fee income by generating fees from Internet service arrangements like bill presentment and clearing.
However, if smart cards or stored value cards or other electronic cash substitute gain popularity, alternatives could become more attractive to customers.
On the other hand, banks might be able to reduce costs of servicing the retail customers by moving them over into a paperless environment.
Banks could introduce various incentives to the persuade customers to forego paper statements for the basic savings account and credit card, says moody’s.
THE RULES HAVE CHANGED
As the 1900s come to their close and we look eagerly towards the new millennium, a revolution that will change the rules and every thing we have understood of the retail market, financial products and other services. Economic boundaries are disappearing, and the global village is a reality – where the retail customer will have a choice in a manner we may have never imagined.
Providers of retail products and services will battle for market and market share. It is battle that will be fought at different levels and the real winner will be the customer, who will benefit from increased competition through better products, distribution, technology, pricing, and post transaction service.
The quality and range of products will expand exponentially –convenience of usage, customization to individual needs, and a host of other user-friendly add-ons will create a whole new frontier of applications. Companies will have to innovate and continuously upgrade their products. Anticipation, listening and responding to your customers needs, will be the buzz-words of this thrust.
Distribution will be the next key benchmark of success. The customer will demand (and therefore the provider will have to respond) for greater convenience of access to the product or service and all this at the best cost of delivery. Re-defined methods, the use of technology – specifically the Internet-and realigned strategies will drive this important criterion of success. Constraints of location, timing, accessibility etc will all be history. No matter how brilliant the product you have, your distribution flexibility will be the customers’ selection parameter.
Again, quality of the product and responsive strategies for distribution will also have a link to price. Efficiencies on this front will be the next item on your report card. Through innovation in production and delivery and cost reduction strategies, the price to the customer will have to be at maximum benefit. The intelligent customer will be ruthless with any price distortions, which as a consequence of inefficiencies or market exploitation – his cost benefit analysis will not allow for these variables.
Would you prefer a product, which (hopefully) is never expected to need post sale service or one which offers the best after sale service if required ? Clearly, the relationship with the customer starts with the transaction, does not and with it. Organisation we have to give equal importance to cost sale needs of customers as the pitch made prior to the sale.
Technology will perhaps be the single largest driver of this detail thrust. The entire strategy will evolve around the absolute ability of the organisation to be at the cutting as edge of technology. We will have to invest in technology far ahead of immediate needs and be able to anticipate the future direction at a pace we are perhaps not used to. Being able to keep abreast, but more importantly, being able to recognize the immense potential that technology provides at all stages in the retail chain will be of paramount importance. To leverage, exploit and link technology to your business will be the greatest challenge of the new millennium and I am convinced that the retail war will be won and lost on this one aspect, purely because technology increasingly we influence on the entire chain in a retail business cycle.
Above all these, I would list attitude towards customer as the single point basis on determining the winner of the race. Attitude to the customer will influence all the areas we have discussed and will ensure excellence in each one of them. It is an intangible, it is not prescribed in a manual nor is it a quantifiable item in the balance sheet, but an organizations attitude to the customer will be the basis determinant of success for any retail operation.
There are interesting and challenging times ahead – the future promises a lot but will also make extraordinary demands. The customer will be the most important aspect of your business and ultimately the winner of the retail war.
RISK INVOLVED IN RETAIL BUSINESS
There are of course, considerable risks in retail banking. They are :
(a) Databases on credit history are large.
(b) Collection mechanisms are poor.
(c) Investments in technology are large.
(d) Operating efficiency level needs to be very high.
(e) Unlike corporate banking, retail banking involves a large number of small accounts.
(f) Demands on processing capabilities are higher.
(g) Retail segment is not something you can get into overnight.
(h) The right systems and the right – architecture needs to be put in place first.
Banking History of Bangladesh
Foreign-owned banks were permitted to continue doing business in Bangladesh.
The insurance business was also nationalized and became a source of potential investment funds.
Cooperative credit systems and postal savings offices handled service to small individual and rural accounts.
The new banking system succeeded in establishing reasonably efficient procedures for managing credit and foreign exchange. The primary function of the credit system throughout the 1970s was to finance trade and the public sector, which together absorbed 75 percent of total advances. The government's encouragement during the late 1970s and early 1980s of agricultural development and private industry brought changes in lending strategies. Managed by the Bangladesh Krishi Bank, a specialized agricultural banking institution, lending to farmers and fishermen dramatically expanded. The number of rural bank branches doubled between 1977 and 1985, to more than 3,330. Denationalization and private industrial growth led the Bangladesh Bank and the World Bank to focus their lending on the emerging private manufacturing sector. Scheduled bank advances to private agriculture, as a percentage of sectoral GDP, rose from 2 percent in FY 1979 to 11 percent in FY 1987, while advances to private manufacturing rose from 13 percent to 53 percent.
The transformation of finance priorities has brought with it problems in administration. No sound project-appraisal system was in place to identify viable borrowers and projects. Lending institutions did not have adequate autonomy to choose borrowers and projects and were often instructed by the political authorities. In addition, the incentive system for the banks stressed disbursements rather than recoveries, and the accounting and debt collection systems were inadequate to deal with the problems of loan recovery. It became more common for borrowers to default on loans than to repay them; the lending system was simply disbursing grant assistance to private individuals who qualified for loans more for political than for economic reasons. The rate of recovery on agricultural loans was only 27 percent in FY 1986, and the rate on industrial loans was even worse. As a result of this poor showing, major donors applied pressure to induce the government and banks to take firmer action to strengthen internal bank management and credit discipline. As a consequence, recovery rates began to improve in 1987. The National Commission on Money, Credit, and Banking recommended broad structural changes in Bangladesh's system of financial intermediation early in 1987, many of which were built into a three-year compensatory financing facility signed by Bangladesh with the IMF in February 1987.
One major exception to the management problems of Bangladeshi banks was the Grameen Bank, begun as a government project in 1976 and established in 1983 as an independent bank. In the late 1980s, the bank continued to provide financial resources to the poor on reasonable terms and to generate productive self-employment without external assistance. Its customers were landless persons who took small loans for all types of economic activities, including housing. About 70 percent of the borrowers were women, who were otherwise not much represented in institutional finance.
Collective rural enterprises also could borrow from the Grameen Bank for investments in tube wells, rice and oil mills, and power looms and for leasing land for joint cultivation. The average loan by the Grameen Bank in the mid-1980s was around Tk2,000 (US$65), and the maximum was just Tk18,000 (for construction of a tin-roof house). Repayment terms were 4 percent for rural housing and 8.5 percent for normal lending operations. The Grameen Bank extended collateral-free loans to 200,000 landless people in its first 10 years. Most of its customers had never dealt with formal lending institutions before. The most remarkable accomplishment was the phenomenal recovery rate; amid the prevailing pattern of bad debts throughout the Bangladeshi banking system, only 4 percent of Grameen Bank loans were overdue. The bank had from the outset applied a specialized system of intensive credit supervision that set it apart from others. Its success, though still on a rather small scale, provided hope that it could continue to grow and that it could be replicated or adapted to other development-related priorities. The Grameen Bank was expanding rapidly, planning to have 500 branches throughout the country by the late 1980s.
Beginning in late 1985, the government pursued a tight monetary policy aimed at limiting the growth of domestic private credit and government borrowing from the banking system. The policy was largely successful in reducing the growth of the money supply and total domestic credit. Net credit to the government actually declined in FY 1986. The problem of credit recovery remained a threat to monetary stability, responsible for serious resource misallocation and harsh inequities. Although the government had begun effective measures to improve financial discipline, the draconian contraction of credit availability contained the risk of inadvertently discouraging new economic activity.
Foreign exchange reserves at the end of FY 1986 were US$476 million, equivalent to slightly more than 2 months worth of imports. This represented a 20-percent increase of reserves over the previous year, largely the result of higher remittances by Bangladeshi workers abroad. The country also reduced imports by about 10 percent to US$2.4 billion. Because of Bangladesh's status as a least developed country receiving concession loans, private creditors accounted for only about 6 percent of outstanding public debt. The external public debt was US$6.4 billion, and annual debt service payments were US$467 million at the end of FY 1986.
Money and Banking-Currency Fluctuation:
At independence the value of the taka, Bangladesh's unit of currency, was set between 7.5 and 8.0 to US$1. With the exception of FY 1978, the taka's value relative to the dollar declined every year from 1971 through the end of 1987. To help offset this phenomenon, Bangladesh first used the compensatory financing facility of the International Monetary Fund (IMF--see Glossary) in FY 1974. Despite the increasing need for assistance, the Mujib government was initially unwilling to meet the IMF's conditions on monetary and fiscal policy. By FY1975, however, the government revised its stance, declaring a devaluation of the taka by 56 percent and agreeing to the establishment by the World Bank of the Bangladesh Aid Group (see Foreign Assistance, this ch.). Between 1980 and 1983, the taka sustained a decline of some 50 percent because of a deterioration in Bangladesh's balance of payments. Between 1985 and 1987, the taka was adjusted in frequent incremental steps, stabilizing again around 12 percent lower in real terms against the United States dollar, but at the same time narrowing the difference between the official rate and the preferential secondary rate from 15 percent to 7.5 percent. Accompanying this structural adjustment was an expansion in the amount of trade conducted at the secondary rate, to 53 percent of total exports and 28 percent of total imports. In mid- 2014, the official rate was relatively stable, approaching Tk79 to US$1.
Overhead Allocation in Determination of Seat Rent of Private Hospitals
Overhead Allocation in Determination of Seat Rent of Private Hospitals
SCOPE AND OBJECTIVE OF THE REPORT
As
a business expectative of future, we should have to gather experience beside
our institutional education. We should not concern our lesson only in classroom
but to implement it in practical life that will help us in our future life.
So,
identify objectives is very much important. Our purpose of preparing the report
is:
To
identify and know the cost allocation methods followed in private hospitals.
To
identify how the private hospitals make their cost allocations for their seat
rent.
To
know how the private hospitals use the cost allocation for their seat rent.
To
find out how effectively they do this job.
METHODOLOGY
OF THE STUDY
Collection
of data is an important part of a term paper preparation. In preparing the
report we have maintained some steps. Which are given bellow —
Step-1:
At first, we select Fortune Hospital ltd. for making our report on “Treatment
of seat rents” practices of a particular organization.
Step-2:
We went to the Fortune Hospital ltd. with group and meet with the director,
doctors’, manager and other employees.
Step-3:
Then we collect various (primary and secondary) data from the manager about the
“Treatment of seat rents”
Step-4:
Process the data through taking helpful hinds from our course teacher M.
Takibur Rahman.
Step-5:
Again analysis and interpretation the data.
Step-6:
Then we calculate the relevant calculations.
Step-7:
Finally, we prepared our report.
LIMITATION
OF THE STUDY
It
was not so easy to us prepare such type of report as the following reasons was
existed.
This
report is based on treatment of overhead allocation in determination of seat
rent. We don’t have sufficient knowledge about cost allocation.
This
is a calculative and analysis based report. So it needs sufficient time. But we
do not have surplus time to make such kind of analytical and calculative
report.
As
the Fortune Hospital ltd. is a private organization, the authority try to keep
some information confidential. As a result we were not capable to collect the
total expected information from them.
Although
we face some limitation, we were trying our best to overcome these complexities
and provide information as far as possible.
CHAPTER:
2 DISCUSSION
2.1
DEFINITION OF OVERHEAD
Any
expenditure which cannot be charge directly to any job, operation or process
may be called overhead. Thus, overhead indicates indirect expenditure of any
kind. It includes indirect materials, indirect wages and indirect expenses.
Eric
l. Kohler defined overhead as “any cost of doing business other than a direct
cost of an output of product or services. He also pointed out that overhead is
“a generic name for manufacturing cost of materials and services not readily
identifiable with the product or services that constitute the main output of an
operation. Overhead therefore, means those expenses, which cannot be allocated
to any product or services (as direct cost) but can be apportioned to or
absorbed by, the product or services.
According
to H. J. Wheldon, overhead represents the cost of indirect materials, indirect
labor and such other expenses including services as cannot be conveniently be
charged to a specific unit. W. W. Bigg says that all indirect costs are termed
as overheads. According to W. M. Harper, overheads are costs which do not
result solely from the existence of individual cost unit.
2.2
DIFFERENT NAMES OF OVERHEAD
Overhead
has many other names such as overhead cost, overhead expense, overhead charge,
manufacturing and commercial expense, indirect cost, non productive cost,
supplementary expense, supplementary cost, burden, on cost, load, loading etc.
Sometimes
distinctions are drown between these terms but such distinctions are not
consistently observed. In fact, all these terms are used to mean the same thing
that is overhead.
2.3
CLASSIFICATION OF OVERHEAD
Overhead
may be classified in various ways as stated below-
A)
Function wise classification
B)
Element wise classification
C)
Behavior wise classification
D)
Control wise classification
Let
us discuses each of the above briefly-
A.
Function wise classification
Every
manufacturing organization has three distinct functions, they are
i)
Production function
ii)
Administrative function
iii)
Selling and distribution function.
Stores
expenses, time office expenses, pay-roll department expenses, transport cost,
super vision cost, factory clerical cost, in direct labor, personnel department
expenses, factory supplies, maintenance and repair, insurance, depreciation,
canteen expenses, rent and taxes etc are the examples of production overhead.
Rent,
rates and taxes of administrative building, salary of the staff office
connected with general administration, depreciation of office equipment and of
building, postage, telegram and telephone, stationary, office expenses,
director’s remuneration, bank charges etc. are the examples of administration
overhead.
Sales
men’s salary and commission, advertisement expenses, travelers commission,
market research expenses are the examples of selling overhead.
Godown
expenses in connection with storing of finish product, awaiting sale, packaging
charges, loading and unloading, insurance, maintenance, and repair of delivery
vans are the examples of distribution overhead.
B)
Element wise classification
If
indirect expense are classified element wise we come across three classes
1.
Indirect materials
2.
Indirect labor
3.
Indirect expenses
1.
Indirect materials:
Administration:
Stationary, canteen food, cleaning materials etc.
Selling
and distribution: Stationary, fuel etc.
2.
Indirect labor:
Factory:
salary of foreman, supervisors, works managers etc. wages of maintenance and
repairs staff, wages of indirect workers etc.
Administration:
salary of all employees of administrative function from managing director to sweeper,
directors remuneration etc.
Selling
and distribution: salary of sales officers, staff and distribution men.
3.
Indirect expenses:
Factory:
Repairs and maintenance, rent, rates and taxes, insurance, depreciation etc.
Administration:
all expenses in connection with general administration.
Selling
and distribution: Godown rent, insurance, advertisements, depreciation etc.
C)
Behavior wise classification
Fixed
overhead: Rent, rates, insurance, stationary, salary of management staff etc.
Variable
overhead: Indirect labor, indirect material, power, packaging, travelers,
salesmen’s commission etc.
Semi-variable
or semi-fixed overhead: repairs and maintenance, depreciation, supervisors
salary etc.
D)
Control wise classification
Overhead
costs which can be controlled by the exercise of proper managerial influence
are controllable costs and overhead costs that cannot be controlled in spite of
the best exercise of managerial influence are uncontrolled labor costs.
2.4
METHODS OF OVERHEAD ALLOCATION
Service
departments, by definition, don't produce marketable goods. Their costs,
therefore, have to be allocated to those departments that use the services.
From there the costs are allocated further, either to other departments or to
products. There are mainly three methods for overhead allocation for service
department. They are-
1.
The direct method.
2.
The step-down method.
3.
The reciprocal method.
1.
The direct method, which is the most widely used allocation method, allocates
each service department's costs directly to the production departments,
ignoring services rendered to other service departments.
2.
The step-down method, also widely used, allocates costs of service departments
to both production and service departments. The sequence of allocation usually
begins either with the department rendering service to the greatest number of
other service departments (or, alternatively, the most costly service
department) and progresses all the way to the one rendering service to the
smallest number of other departments (or to the least costly department). Once
a service department's costs have been allocated, no subsequent
service-department costs are allocated back to it.
3.
The reciprocal method is the most accurate allocation method. This method recognizes
reciprocal services among service departments. It requires solving
a
set of simultaneous linear equations.
OVERVIEW
OF SELECTED ORGANIZATION (FORTUNE HOSPITAL)
“Providing
medical facilities with great care” with this objective in 2005 fortune hospital
has been established in Patuakhali. As it is a private hospital, it has a
objective of earning profit but their objective is “Earning profit by serving
and providing maximum effort.”
The
owner of the hospital is Dr. Fazle Rabbi, MBBS (DMC); Specialist in
Neuromedicine, RMO, department of Neuromedicine, BSMMU (PG hospital),
with
the co-owner ship of Dr. Shirin Akter, MBBS.
This
hospital is a newly established hospital in Patuakhali. They are now working by
taking rent a 4 stored building with a rent of Tk 24000 per month. They have
four appointed doctors. Two of them are dentist and other two are of medicine.
They give about Tk 12000 as remuneration (basic salary). They provide some
other facilities to each doctor. For any kind of additional service, they call
guest doctors from Patuakhali, Barisal as well as from Dhaka. Dr. Fazle Rabbi
also visits the hospital in more than 4 times in a month.
They
have 12 sisters and 5 words boy to serve 24 hours in the hospital by rotation.
They have one manager, one accountant and two receptionists. They also have a
pathologist and an electrician.
Fortune
hospital is a 20-bed hospital. Within these 20 beds 15 is for general and 5 for
the VIP patient. The seat rent is also different in these two categories. For
general bed they charge Tk 150 per day and Tk 700 per day for the VIP beds.
They
also provide outdoor facility for the patients. For this, each patient has to
pay Tk 200 for service charge. Four days in a month, they provide service by
the help of specialist doctors from Dhaka.
Though
Fortune hospital is a newly established hospital it is working well and they
are now in a position of good competitor for other private clinics of
Patuakhali.
With
the help of generator, they provide 24 hours electricity.
CHAPTER:
3 CALCULATION AND ANALYSIS
3.1
CALCULATION OF WEIGHT OF REVENUES
Data
will follow...
CHAPTER:
4
FINDINGS
Fortunr
hospital has only three sources of revenue they are, out door income, seat rent
and operation theater charge.
They
have the total income of Tk 2361500 and from the seat rent; they earn Tk
997500, revenues per year.
This
seat rent is collected from two types of seat- general bed and VIP bed.
Their
rent per seat is Tk150 for general and Tk. 700 for VIP seats per day.
Their
cost per seat per day is Tk. 87.70 for general bed and Tk. 405 for VIP bed.
Fortune
hospital ltd. are in a profit position for general bed for Tk. 62.3 (per day
allocation) and profit Tk. 295 from VIP bed (per day allocation).
Their
profit from general bed is 41.53% and profit from VIP bed is 42.14%.
Their
profit margin for outdoor revenue is 37.71% and from Operation Theater, charge
is 32.59%.
CHAPTER:
5 CONCLUSION AND RECOMMENDATIONS
5.1
CONCLUSION
Cost
allocation is one of the most difficult tasks in running any business.
Accurately understanding the costs, however, are imperative if anyone want his
business to succeed. One has to price the products or services in a way to be
profitable and allocating costs is a major part of profitability.
Overhead
allocation is one of the more confusing and complex issues facing many
businesses. Yet, figuring out how to best determine overhead is very important
to a firm’s profitability. Here, for the calculation of overhead and direct
expenses we used the physical output measure. From the overall calculation, we
get the cost per bed and the profit per day per bed. This calculation gives us
the result that the private hospital is making about 41.53% profit from their
general seat and 42.14% profit from VIP bed. They have only other two types of
revenue source as outdoor revenue and operation theater charge. The profit
margin of outdoor revenue and operation theater charge is 37.71% and 32.59%.
We
try to make this report as correct as possible with the help of the information
has been supplied by the Fortune Hospital authority.
5.2
RECOMMENDATION
They
have only three sources of revenue. They are --from the seat rent, from the
outdoor and from the operation theater charge. They must try to increase their
sources of revenue.
Today’s
market is competitive market. In private hospital or clinic sector there are
number of competitors. So to exist in this competitive market Fortune hospital
should try to increase their health services.
Their
hospital in a rental building for which they have to give Tk. 24000 per month.
That is why, though it is a newly establish hospital should try to make their
own hospital building.
It
is only 20 beds hospital. To meet the increasing demand in medical sector they
should try to increase their bed capacity with modern medical instruments.
This
hospital is in Patuakhali district. And they are in a profit position in terms
of general bed for about 41.53% and profit from VIP bed is about 42.14%. For
this reason, their seat rent basically in general bed and in VIP bed is in
somehow properly allocated. But in this competitive market to derive more
client they can minimize their seat rent.
Their
cost for each general bed is Tk. 87.70 and Tk. 405 for VIP bed. But the seat
rent for general is Tk. 150 and for VIP is Tk. 700. So they can take client
driven policy if the management is aggressive.
To
days, market is very much competitive. So in taking any type of decisions they
should be very much careful.
There
is no ambulance service by the Fortune hospital. They should try to provide
this facility as early as possible.
5.3
BIBLIOGRAPHY
1.
Matz Adolph & Usry Milton F.; Cost Accounting Planning and Control ; 8th
edition,
South western publishing company.
2.
Basu Sankar Prasad & Das Monilal; Theory and practice of costing
(Volume
one); 13th edition, Rabindra library.
3.
Horngren Charlest T., Datar Srikant M. & Foster George; Cost Accounting;
12th
edition, Prentice hall of India private limited.
5.4
Appendices
Fortune
hospital ltd.
Sher-E-Bangla
Road, Patuakhli
Cost Accounting System
Cost Accounting is that part of the cost management system that measures costs for the purpose of management decision making and financial reporting. The cost accounting system typically includes two processes:
1. Cost accumulation: Collecting costs by some "natural" classification such as materials or labor, or by activities performed such as order processing or machine processing.
2. Cost assignment: Tracing or allocating costs to one or more cost objectives such as activities, processes, departments, customers, or products.
Cost: A sacrifice or giving up of resources for a particular purpose, frequently measured by the monetary units that an organization must pay for goods and services.
Cost object: Anything for which decision makers desire a separate measurement of costs. Examples include departments, products etc.
Direct costs: Costs that can be identified specially and exclusively with a given cost objective in an economically feasible way.
Indirect costs: Costs that can not be identified specifically and exclusively with a given cost objective in an economically feasible way.
Cost allocation: Assigning indirect costs to cost objects using plausible and reliable cost drivers.
Unallocated costs: Costs for which we can identify no relationship to a cost objective.
Product costs: Costs identified with goods produced or purchased for resale.
Period costs: Costs that become expenses during the current period without going through an inventory stage.
Cost pool: A group of individual costs that a company allocating to cost objectives using a single driver.
The role of various cost concepts in decision making process
The name of my project is " The role of various cost concepts in decision–making process " In this assignment I am trying to define the cost first then show how they are playing role in different situation. The costs that I discuss about are as follows:
Manufacturing costs
Non-manufacturing costs
Fixed costs
Variable cost
Absorption costing
Variable costing
Opportunity costs
Sunk costs
Product costs
Period costs
Differential costs
Standard costs
Direct cost & Indirect cost
Mixed cost.
Manufacturing costs:
Most manufacturing companies divide manufacturing cost into three broad categories. Direct material, Direct labor and Manufacturing overhead.
Direct material: Direct materials are those materials that become an integral part of the finished product and that can be physically and conveniently traced to it. For example: Panasonic use electric motor in it’s CD Players to make the CD spin.
Direct labor: The term direct labor is reserved for those labor costs that can be easily traced to individual product. Direct labor is sometime called touch labor, since direct labor workers typically touch the product while it is being made. For example the labor cost of machine operator.
Manufacturing overhead: Manufacturing overhead the third element of manufacturing cost, includes all cost of manufacturing except direct material and direct labor. So, we can say that all costs associated with operating the factory are included in the manufacturing overhead category. Such as indirect material, indirect labor, maintenance and repairs on production equipment etc.
Role in decision-making
Manufacturing cost is used to determine the inventory valuation on the balance sheet and cost of goods sold on the income statement of external financial reports.
Assume that Tongi national company produce fan. The total manufacturing cost of one unit is 850 taka, where
Direct material: 400 tk
Direct labor: 150 tk
MOH: 300 tk
Total 850 tk
Now from this manufacturing cost the company can decide that how much they want to make profit and set a selling price based on that. Suppose they want to make 20% profit on manufacturing cost then their selling price will be 1020 tk.
But after setting selling price they see that one of their competitor sales their product at 950 tk. In this situation the company can justify the manufacturing cost that where the wrong is going on. If their material price is high then they can buy the raw material from other supplier at low cost to reduce the access cost. If their labor cost is high, then they can hire labor from other at low cost or can cut the number of employee to reduce the cost. By taking this corrective action the company can maintain the manufacturing cost to stay in the market.
Non-manufacturing costs:
Generally non-manufacturing costs are sub-classified into two categories, (1) Selling costs, (2) Administrative costs
Selling costs: Selling cost include all costs necessary to secure customer orders and get the finished product on service into the hand of the customer. This cost is also known as marketing cost. Example: Advertising, Shipping, Sales travel etc.
Administrative costs: It includes all executive, organizational and clerical costs associated with the general management of an organization rather than with manufacturing and selling. Example: Secretarial, compensation, public relation and other this types of costs
Role in decision-making
Non-manufacturing cost is playing a great role in decision-making. In income statement we deduct non-manufacturing cost or operating cost from gross margin to get net profit. Suppose we expect “X” amount of money as net profit. But if the net income falls below than our expectation, then we must reduce operating cost to gain more profit. We can give one example to clear this idea. Suppose our net income is less than our expectation. Now we have to reduce price. We can take advertising cost as a sample. In case of advertising our first motive is to identify our target consumer then we have to select the advertising media. Suppose we make one types of product and our target consumers are fishermen. In this case we must use radio as an advertising media rather than television and it will cost less. By this way we can save non-manufacturing cost. In this purpose we can also reduce the cost of shipping, sales travel, compensation, public relation cost, sales salary etc. to increase net profit.
Fixed costs, variable costs & their role in decision-making
Fixed costs:
A fixed cost is a cost that remains constant in total, regardless of changes in the level of activity. As the activity level rises and falls, the fixed cost remains constant in total amount unless influenced by some outside force, Such as price changes. There are two types of fixed cost.
(1) Committed fixed cost: Committed fixed costs relate to the investment in facilities, equipment and the basic organizational structure of a firm. Example: Rent.
(2) Discretionary fixed cost: Discretionary fixed cost usually arise from annual decisions by management to spend in certain fixed cost areas. Example: Advertising.
Role in decision-making
Usually fixed cost is used to determine break-even point. The formula for break-even point is = fixed cost Cm per unit.
Suppose our fixed cost = $ 20,000
Selling price = $ 250
Variable cost = $ 150
Then break-even unit = {20,000 (250 – 150)}
= 200 unit
In the break-even point there is no profit as well as no loss at all. We have calculated break-even point to determine the sales level and using this method we can also calculate the number of unit to gain our expected profit.
Reduction of fixed cost is also very important to increase net income. If we reduce fixed cost per unit then it will contribute to net income. Suppose our production is not running in our full capacity level then we can increase production in order to reduce our fixed cost per unit. For example:
Capacity: 400 Units
Production: 300 Units
Fixed cost: $20,000
Variable cost: $150
Selling price: $250
Current income statement
Sales = $75,000
(300 250)
(-) V. cost = $45,000
(300150)
Cm $30,000
(-) F. cost = $20,000
Net income $10,000
Here we see that in the current situation we have a net income of $10,000. Now we get an offer from outside to deliver 100 extra units at $200. In this case our proposed net income as follows:
Proposed income statement
Sales = $95,000
(300 250) + (100200)
(-) V. cost = $60,000
(400150)
Cm $35,000
(-) F. cost = $20,000
Net income $15,000
In this case we will accept the proposal because our proposed net income is greater than the current net income. Though the proposed selling price is less than current one but we can generate more income because in this case fixed cost goes down from (20,000 300) = $66.67 to (20,000 400) = $50.00, So here we see that how fixed cost plays effective role in decision-making.
Variable cost:
A variable cost is a cost that varies in total, in direct proportion to changes in the level of activity. The activity can be expressed in many ways, such as units produced, units sold, miles driven, lines of print and so forth. A good example of variable cost is direct material. It is important to note that when we speak of a cost as being variable, we mean the total cost rises and falls as the activity level rises and falls. There are two types of variable cost.
(1) True variable cost: Direct material is a true variable cost because the amount used during a period will vary in direct proportion to the level of production activity.
(2) Step-variable cost: A cost that is obtained only in large chunks and that increases or decreases only in response to fairly wide changes in the activity level is known as step-variable cost. Maintenance cost is an example of step-variable cost.
Role in decision-making
Variable cost plays a great role in decision-making we know that if we increase our production then our variable cost will also increase. So we have to concentrate on reduction of total cost and in this case we must consider fixed cost also. If we increase our production within our capacity, our unit cost of production will decrease. Because as production increase variable cost will also increase but fixed cost per unit will decrease.
Suppose,
Variable cost = $1
Fixed cost = $10
Capacity = 20 unit
Production Variable cost Fixed cost Total cost
unit per unit per unit per unit
5 1 2 3
10 1 1 2
15 1 .56 1.56
Here we see that as production increases total cost per unit decrease because fixed cost per unit continuously decreases. So, in case of reducing total cost we must increase the production level. And as we know variable cost is constant so we must try to reduce the total cost from other sector to generate more profit. Thus variable cost has a significant impact on selling price.
Variable cost is also used to calculate cm per unit, cm ratio, margin of safety, degree of operating leverage and other this types of important things.
Absorption costing:
A costing method that includes all manufacturing costs, direct materials, direct labor and both variable and fixed overhead as part of the cost of a finished unit of production.
For example in this method the unit cost is as follows:
Unit cost
Direct material: 03
Direct labor: 02
Variable MOH: 03
Fixed MOH: 02
Total $ 10 per unit
Here fixed and variable MOH both are considered.
Role in decision-making
Absorption costing is the generally accepted method for preparing mandatory external financial reports and income tax returns. Absorption costing treats fixed manufacturing overhead as a product cost. If fixed costs are treated as period costs and there is a low level of sales activity in a period then a low profit or a loss will be recorded. If there is a high level of sales activity there will be relatively high profit. Absorption costing creates a smoothing of these fluctuations by carrying the fixed costs forward until the goods are sold. Many firms use the Absorption approach exclusively because of its focus on full costing of units of product.
Variable costing:
In variable costing, only variable costs of production are allocated to products and the unsold stock is valued at variable cost of production. Fixed production costs are treated as a cost of the period in which they are incurred.
For example in this method the unit cost is as follows:
Unit cost
Direct material: 03
Direct labor: 02
Variable MOH: 03
Total $ 08 per unit
Here fixed MOH is not considered.
Role in decision-making
Variable costing is used internally for planning purposes. Under Variable costing, only those production costs that vary with output are treated as product cost. This includes direct material, direct labor and variable overhead. Fixed manufacture overhead is treated as a period cost and charged off against revenue as it is incurred, the same as selling and administrative expenses. Under Variable costing, the profit for a period is not affected by changes in inventory. This cost is particularly important for company having cash flow problems. One thing is very important that when Variable costing is in use profits move in the same direction as sales. We can also take the data for CVP analysis directly from a contribution margin format income statement that are not available on a conventional income statement based on absorption costing. The Variable costing approaches are often indispensable in profit planning and decision-making.
Opportunity costs, Sunk costs & its role in decision making
Opportunity costs:
Opportunity cost is the potential benefit that is given up when one alternative is selected over another. For example: Suppose I worked in a company and it gives me 20,000 taka per month. But suddenly I leave that job and get admitted in North-South University for M.B.A. Then my salary 20,000 taka is my opportunity cost which I sacrificed for further education.
Role in decision-making
Opportunity cost is a very important item, which is playing an effective role in decision-making. By considering opportunity cost we can determine the real cost of production. We can give an example to clear this idea.
Let,
Direct material : $3 (Avoidable)
Direct Labor : $2 (Avoidable)
Supervisor salary : $1 (Avoidable)
Factory rent : $1 (Unavoidable)
Depreciation : $2 (Unavoidable)
Allocated general
Expense : $3 (Unavoidable)
Total cost per unit : $12
Avoidable cost : (3+2+1) = $6
Unavoidable cost : (1+2+3) = $6
Here we see that if we make the material the cost of per unit will be $12. Now we get an offer from outside at $8 per unit. If we want to buy we have to consider some other things because there are some unavoidable cost that we can’t ignore. It will add to the buying cost. Now we see that if we buy it will costs (8+6) = $14 per unit. So we can easily determine that we will go for making not buying. In this case we have to consider opportunity cost. Suppose the room, where we will make our production, the rent of that room is $20,000 and we get an offer for 5,000 unit.
Make Buy
Unit cost $12 $14
For 5,000 unit $60,000 $70,000
(+) Opportunity cost $20,000 ------
Total cost $80,000 $70,000
Here we see that if we go for making it will cost more and if we buy raw material from outside we can generate $10,000 as a profit. So, in this case we will definitely go for buy not make.
Sunk costs:
A sunk cost is a cost that has already been incurred and that cannot be changed by any decision made now or in the future. So, they should be ignored when making decision. Example: Suppose we buy a machine costs 50,000 taka to produce one kind of goods. But now there is no longer demand of that product. So we buy another new machine costs 70,000 taka. Now there is no use of old machine and we have already incurred that cost. So, here 50,000 taka is sunk cost, which was paid for purchasing of old machine.
Role in decision-making
Sunk cost does not play any role in decision-making. On the other hand it plays a great role in decision -making. Usually we deduct the sunk cost from both keep old machine & purchase of new machine. By this way we can show the proper fixed cost. Suppose our sunk cost is $50,000 but the salvage value of that machine is $20,000. Now if we don’t consider the sunk cost then it will show us $20,000 income and if we consider sunk cost, ultimately it will show us 30,000 losses. Thus sunk cost plays an effective role to show proper income. Sunk cost is also playing a great role in another criteria. If we don’t deduct the sunk cost from fixed cost then our fixed cost will be greater and our unit cost will increase also. In this case we cannot compete with our competitors. So we must deduct sunk cost from our account.
Product costs, period costs & role in decision making
Product costs:
Product costs include all the costs that are involved in acquiring or making a product. In the case of manufacturing goods these costs consist of direct material, direct labor and manufacturing overhead. Product costs are initially assigned to inventories. So, they are known as inventoriable costs.
Role in decision-making
If an organization want to minimize their inventory cost they can fallow just in time process. In this process the cost of inventory is less than the normal process. So, the product cost is minimized and it will help to generate more profit.
If an organization follows normal process for manufacturing goods, then they must reserve material for future and it will cost a lot. Such as rent for place, guard salary, maintenance cost. And it will reduce net income. So, they must follow just in time process to increase the net income.
Period costs:
Period costs are all the costs that are not incurred in product costs. These costs are expensed on the income statement in the period in which they are incurred, using the usual rules of accrual accounting. Period costs are not included as part of the cost of either purchase or manufactured goods. Example: Sales commission, Office rent.
Role in decision-making
Depending on period cost we can also take some corrective action. Normally sales commission, office rent and other these types of cost are included in period cost. Suppose our net income is lower than our expectation then we can increase our net income by reducing period cost. Let’s take office rent. If our office rent is high then we can reduce the rent by shifting office place. However for many decision-making purposes the period costs are seen as being non-controllable in the short-term, so that attention may focus on product cost.
Differential costs, standard costs and role in decision-making
Differential costs:
A difference in costs between any two alternatives is known as differential cost. A differential cost is also known as incremental cost. Technically an incremental cost should refer only to an increase in cost from one alternative to another. Decreases in cost should be referred to as decremental costs. So here we see that differential cost is broader term consist of both incremental cost & decremental cost.
Role in decision-making
Differential cost can be either fixed or variable. To illustrate assume that Keya cosmetics ltd. is thinking about changing it’s marketing method from distribution through retailer to distribution by door-to-door direct sale. Present cost and revenues are compared to projected costs and revenues in the following table:
Retailer Direct sale Differential cost
Distribution Distribution and revenue
Revenue $500,000 $600,000 $100,000
Deduct =======================================
Cost of good sold $150,000 $200,000 $50,000
Advertising $50,000 $25,000 $(25,000)
Commission - 0 - $20,000 $20,000
Depreciation $25,000 $50,000 $25,000
Other expenses $20,000 $20,000 -- 0 --
Total $245,000 $315,000 $70,000
Net income $255,000 $285,000 $30,000
======================================
According to the analysis the differential revenue is $100,000 and the differential cost is $70,000 leaving a positive differential net income $30,000 under the proposed marketing plan.
From the given table the company can easily decide that which marketing plan they should follow. As we see in the above analysis the net income under door-to-door is $30,000 higher than the previous one. And they can get it simply focusing on differential cost, revenue and net income. By this way differential cost helps in decision-making.
Standard costs:
Standard costs are target costs, which should be attained under specified operating conditions. They are expressed as a cost per unit. For example: Hospitals have standard cost (for food, laundry and other items) for each occupied bed per day, as well as standard time allowance for certain routine activities, such as laboratory test.
Role in decision-making
Standard cost is used to integrate costs in the planning and pricing and pricing structure of a business. Once the Standard cost has been decided, the actual cost may be compared with the standard. If it equals the standard then the actual outcome has matched expectations. If the actual cost is different from the standard cost allowed, then there will be variance to be investigated, whether it is favourable or unfavourable. When the actual cost is less than the standard cost then it is called favourable and when the actual cost is greater than the standard cost then it is called unfavourable. In case of favourable term management will accept the proposal and in case of unfavourable term, they will reject it.
Direct cost & Indirect cost
Direct cost, indirect cost, mixed cost and role in decision-making
Direct cost:
A direct cost is a cost that cannot be easily and conveniently traced to the particular cost object under consideration. The concept of direct cost extends beyond just direct material and direct labor. Example: Suppose woodland company is assigning costs to it’s various regional and national sales offices. Then the salary of the sales manager in its Bombay office would be a direct cost of that office.
Indirect cost:
An indirect cost is a cost that cannot be easily and conveniently traced to the particular cost object under consideration. For example: Igloo company makes varieties ice-cream. The factory manager’s salary would be an indirect cost of a particular variety such as igloo chocbar.
Role in decision-making
Direct cost includes direct material, direct labor; on the other hand indirect cost includes indirect material and indirect labor. They are playing a great role in decision-making, but not individually. They have a significant impact on manufacturing cost, because these costs are included in manufacturing cost. So ultimately they are playing role in setting selling price.
Mixed cost:
A mixed cost is one that contains both variable and fixed cost elements. Mixed costs are also known as semi-variable cost. Mixed cost is calculated by following equation.
Y = a bx
Here Y = Total cost
a = fixed cost
b = Variable cost
x = Total unit.
The fixed portion of a mixed cost represents the basic, minimum cost of just having a service ready and available for use. The variable portion represents the cost incurred for actual consumption of the service. The account analysis and the engineering approach is used to estimate the fixed and variable portion of a mixed cost.
For example: The cost of providing X-ray services to the to patients at the P>G hospital is a mixed cost. There are substantial fixed costs for equipment depreciation and for salaries for radiologists and technicians but there are also variable costs for X-ray film, power and supplies.
Role in decision-making
Mixed costs also have some role in decision-making because this cost is a combined form of fixed and variable cost. As we know fixed costs are constant but variable cost differs with the production level. So, by reducing the variable cost we can decrease total unit cost and it will help to increase net income.
Conclusion
If any organization wants to run a manufacturing company successfully then the management needs to take proper decision on time. . Most decisions will at some stage involve consideration of financial matters, particularly cost. Decisions may also have an impact on the working conditions and employment prospects of employees of the organization, so that cost considerations may, in the final analysis, be weighed against social issues. If the management can control the cost then the company will generate more profit, on the other way they will suffer loss. So, by going through this project we can easily understand how different types of cost play role in decision-making and we can apply these terms in practical life.
Sources:
1. Managerial Accounting
Ray H. Garrison
Eric W. Noreen
2. Introduction to Management Accounting
Professor Pauline Weetman
Paul Gordon
3. Class lecture
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