Cost analysis

A
Presentation on
Cost analysis

Introduction
• Cost analysis assumes a great significance in
all major business decisions because the term
‘cost’ has different meaning under different
settings and is subject to varying
interpretations.
• The analysis cost is an important factor in
almost all business analysis and business
decision making like

a) locating the weak points in the production
management.
b) Minimizing the cost.
c) Finding the optimum level of output.
d) Determining price and dealers; margins.
e) Estimating or projecting the cost of operation.

COST CONCEPT & TYPES
• OPPORTUNITY COST –
• Opportunity cost of a product is value of the next best
alternative forgone (that is not chosen).
• It can also defined as the revenue forgone for not
making the best alternative use.
• The concept of opportunity cost is useful for manager
in decision making.

ECONOMIC COST
• This cost includes explicit and implicit cost both. In
other words, economic cost includes both recorded
and unrecorded cost.
 EXPLICIT COST is the actual money expenditure
on inputs or payments made to the outsiders for
hiring the factor services.
Example – wages paid to employees, payment for raw
materials etc.

IMPLICIT COST is the cost of self supplied
factors .
Example- Interest on own capital ,Rent of own
land etc.
The sum of explicit cost and implicit cost is the
total cost of production of a commodity.

ACCOUNTING COST
• Accounting cost is the cost based upon
accounting records in the book of accounts.
• They are recorded in the book of accounts
when they are actually incurred . Its based on
Accrual concept.
• Accounting costs are explicit cost and must be
paid.

PRIVATE COST & SOCIAL COST
• Private costs are those which are actually incurred by
a firm on the purchase of goods and services from
the market. For a firm, all actual costs both explicit
and Implicit are private costs.
• Social Costs refers to the total cost borne by the
society due to production of a commodity

Incremental and Sunk Costs
• Incremental costs are closely related to
marginal costs, incremental costs refers to the
total additional cost associated with the expand
in output.
• Sunk Costs are those which cannot be altered,
increased or decreased by varying the rate of
output.

Short Run and long run costs
• Short run costs are costs that vary with
variation in output. Short run costs are the
same as variable costs
• Long run costs are costs that are incurred on
fixed assets like plant, machinery, etc

DIRECT AND INDIRECT COST
• Direct cost are the costs that have direct
relationship with a unit of operation. This
includes items such as software, equipment,
labor and raw materials.
• Indirect cost are those cost whose cost can’t
be easily traced to a product such as
electricity , stationary and other office
expenses.

TOTAL COST
Total cost is the actual money spends to produce
a particular quantity of output.
It is the summation of fixed and variable costs
TC = TFC+ TVC
 TFC(Total Fixed Cost):
Total fixed costs, i.e the cost of plant, building,
equipment etc. remain fixed with a change in output.
 TVC(Total Variable Cost):
The total variable cost i.e the cost of labour, raw
material etc varies with the variation in output.

AVERAGE COST
Average cost is the total cost of producing per unit of
commodity. It can be found out as follows
AC= AFC +AVC
AC= Total cost/no.of units produced
 AFC (Average fixed Cost)-
Fixed cost of producing per unit of the commodity.
AFC= total fixed cost / no. of units produced.
 AVC (Average Variable Cost)
Variable cost of producing per unit of the commodity.
AVC= total fixed cost / no. of units produced.

MARGINAL COST
• Marginal cost is the additional to total cost
when one more unit of output is produced .
• It can be arrived by dividing the change in
total cost by the change in total output.
MC = 







Q
TC

Cost-output relationship has 2 aspects:
Cost-output relationship in the short run,
Cost-output relationship in the long run
The SHORT RUN is a period which doesn’t permit
alterations in the fixed equipment (machinery , building
etc.) & in the size of the org.
The LONG RUN is a period in which there is sufficient
time to alter the equipment (machinery, building, land
etc.) & the size of the org. output can be increased
without any limits being placed by the fixed factors of
production

Cost-output Relationship In The
Short Run

Short Run may be studied in terms of
 Average Fixed Cost
 Average Variable Cost
 Average Total cost

Total, average & marginal cost
TC) = TFC + TVC, rise as output rises
1. Total cost (TC) = TFC + TVC, rise as
output rises
2. Average cost (AC) = TC/output
 3. Marginal cost (MC) = change in TC as
a result
 of changing output by one unit
Fixed cost & variable cost
1.Total fixed cost (TFC) = cost of using fixed
factors = cost that does not change when
output is changed, e.g.
2. Total variable cost (TVC) = cost of using
variable factors = cost that changes when

Average Fixed Cost and Output
The greater the output, the lower the fixed cost
per unit, i.e. the average fixed cost.
Total fixed costs remain the same & do not change
with a change in output.
Average Fixed Cost and Output
The greater the output, the lower the fixed cost
per unit, i.e. the average fixed cost.
Total fixed costs remain the same & do not change
with a change in output.

Average Total cost and output
Average total cost, also known as average costs,
would decline first & then rise upwards.
Average cost consists of average fixed cost plus
average variable cost.
Average fixed cost continues to fall with an increase in
output while avg. variable cost first declines & then
rises.
So , as Avg. variable cost declines the Avg. total cost
will also decline. But after a point the Avg. variable
cost will rise.
When the rise in AVC is more than the drop in Avg.

RELATIONSHIP BETWEEN MARGINAL AND AVERGAE
COST
• The marginal costs and average costs are
related.
• When marginal cost exceeds average cost,
average cost must be rising.
• When marginal cost is less than average cost,
average cost must be falling.
• The position of marginal cost relative to
average total cost tells us whether average
total cost is rising or falling.

Relationship between Marginal Cost and Average cost
• If MC>ATC, then ATC is rising
• If MC>MVC , then AVC is rising
• If MC< ATC, then ATC is falling
• If MC<AVC, then AVC is falling
• If MC=AVC and MC=ATC, then AVC and ATC are
at there minimum points

DEFINITION
They are costs over a long period of
time.
They permit for enough change in all
factors of production.
Thus firms can produce more.
Supply of a commodity is adjusted to its
demand.

LONG RUN COST CURVES
All costs are variable in the long run.
There are only average variable cost in
long run, since all factors are variable.
It is also called as planning curve or
envelope or scale curve.

Production Rules for the Long Run
 If selling price > ATC (or TR > TC):
• Continue to produce.
• Maximize profit by producing where MR =
MC.
 If selling price < ATC (or TR < TC):
• There will be a continual loss.
• Sell the fixed assets to eliminate fixed
costs.
• Reinvest money is a more profitable
alternative.

Economies of Scale:
Economies of Scale are the cost
advantages that a firm obtain due to
expansion.
Factors responsible for this:
• Use of technically efficient machines.
• Division of labor.
• Indivisibility
• Financial economics.

Diseconomies of Scale:
 Increase in long-term average
cost of production as
the scale of operations increases beyond a
certain level.
After a certain sufficiently large size these
inefficiencies of management more than
offset the economies of scale and thereby
bring about the rise in long run average cost
& make the LAC curve upward sloping.

Factors determining the cost are
(a) Size of plant: There is an inverse relationship
between size of plant and cost. As size of plant
increases, cost falls and vice versa.
(b) Level of Output: There is a direct relationship
between output level and cost. More the level of
output, more is the cost ( i. e., total cost) and vice
Versa.
(c) Price of Inputs: There is a relationship between
price of inputs and cost. As the price of inputs rises,
cost ruses and vice versa.

(d) State of technology: More modern and upgraded
the technology implies lesser cost and vice versa.
(e) Management and administrative efficiency:
Efficiency and cost are inversely related. More the
efficiency in management and administration better
will be the product and less will be the cost. Cost will
case of inefficiencies in management and
administration.

What is a break-even analysis
• Break-even analysis or what is also known as profit
contribution analysis is an important analytical
technique used to study the relationship between
the total costs (TC), Total revenue (TR) and total
profits and losses over the whole range of stipulated
output.
• The breakeven analysis is a technique of having a
preview of profit prospects and a tool of profit
planning. It integrates the cost and revenue
estimates to ascertain the profits and losses
associated with different levels of output.

To illustrate the break-even analysis under linear cost and
revenue conditions, let us assume linear cost and linear
revenue functions are given as follows.
Cost function: TC = 100 + 10 Q………..eq. (1)
Revenue function: TR = 15 Q……..……eq. (2)
The cost function given in eq. (1) =>
firm’s TFC (total fixed cost) = 100 and its variable cost
varies at a constant rate of 10 per unit in response to
increase in output. The revenue function given in fig.
implies that price for the firm’s product is given in the
market at 15 per unit of sale.

TR
TC
Operating
Loss
B
y
x
200
300
100
700
600
500
400
10 20 4030
output
0
TVC
Break-even Analysis : Linear Function
Operating
profit
Costandrevenue
TFC

• The line TFC shows the total fixed cost at 100 for a
certain level of output.
• The line TVC shows the variable cost rising with a slope.
• The line TC has been obtained by plotting the TC
function.
• The line TR shows the total revenue.
• The line TR & TC lines intersect at point B
• At point B, Q = 20 ;firm’s total cost =total revenue
• At Q=20, TC breaks-even with TR. Point B, therefore the
break-even point and Q= 20 is break-even output.

• Below this level of output, TC exceeds TR.
• Vertical difference TC-TR known as operating loss.
• Beyond Q=20, TR>TC and TR-TC is known as operating
profit.
• It may be noted that a firm producing a commodity
under cost and revenue conditions given in above eq.
(1) & (2).
• Must produce at least 20 units to make its total cost
and total revenue break-even.
• At break-even point, TR = TC

Break–even analysis under non-linear
function

Q1
Break–even analysis under non-linear function
Q2
x
y
TC
TR
TFC
B1
B2
0
Totalcostandrevenue
F
Output per time unit

• TFC line shows the fixed cost at OF and the vertical
distance between TC and TFC measures the total
variable cost (TVC).
• The curve TR shows the total revenue at different
output & price.
• The vertical distance between the TR and TC
measure profit/loss.
• TR & TC curves intersect at two points, B1 & B2,
where TR = TC.
• OQ1 corresponding to break-even point B1 and OQ2
corresponding to break-even point B2 ;TR > TC.
• Profitable range lies between OQ1 and OQ2 units of
output.

Thank you
A presentation by-
1. Aishwarya
2. Arpita
3. Anvita
4. Ajay soni
5. Arpit Kumar Parashar

Cost analysis

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