The other part of the profit equation - controlling costs

Now that we've explored the two ways to generate more revenue, let’s take a look at the remaining factor in our simple equation of costs.

Profits  =  Revenue  –  Costs

Costs can be characterized by many different methods.  Cost-based-accounting, Activity-based-accounting, etc., are just a few examples of how management tries to understand and control how their budgets are being spent.  Let’s look at one of the most common categorization conventions.

Fixed and Variable.  To simplify, think of fixed costs as those outlays of resources that exist despite the successful or unsuccessful operation of the business.  An example would be the electric bill for the HQ building of the company.  While there are measures you can take to control the amount of energy used, you’re going to have an electric bill that will be largely independent (in the HQ building only – not the operations facility!) of production and sales.  So include rent, senior management salaries, etc., in this broad category as they tend to exist and fluctuate independent of the product or service the company produces.

Why this particular distinction?  Because most management teams see fixed costs as “uncontrollable” and variable costs as “controllable.”  This is not the correct application of the term controllable – but it does illustrate the perception that is correct.  Management is “stuck” with fixed costs – at least in the short term period.  They believe, however, that they have a high degree of control over the variable costs of an operation.  Both fixed and variable costs are controllable, so you can see where the use of these applications of “controllable” is incorrect.