Introduction
This paper seeks to analyze whether it is a good idea to convert fixed cots to variable costs for Claire’s Antiques. This will also discuss when it is proper to convert fixed cost to variable cost and will identify the types of costs that Claire’s Antiques would probably incur as fixed costs. At the last part, the paper will also attempt to explain the manner of arriving at the appropriate derivation of cost.
Analysis and Discussion
Converting fixed cost to variable cost is applicable when there is low sales volume or low demand and high profit margin for a certain product. This must be so since high fixed cost would need great sales volume to recover of the same. Since Claire’s Antiques produces three types of antiques which include clocks, dinette sets and bedroom suits, there is a need to understand the profitability level of each type the product and its demand in the market in terms of sales volume. Case facts provide that bedroom suits have a higher net profit margin but with a lower sales volume in comparison with other two products1.
This means that it is advisable for Antiques to convert some fixed cost to variable cost for bedroom suites in order to reflect a higher profitability. As a general rule, the higher the sales volume, the higher would be the variable cost. Similarly, the lower the sales volume the lower would be the variable cost and the higher would be the profitability. Thus is not surprising that companies with high sales volume for their products are advised to have high fixed cost since the company would be able to have an economy of scale. This is very evident in the case or car manufacturing industry where the high fixed cost has become a barrier to entry.
On the other hand, converting fixed cost to variable cost is not applicable where the opposite happens – that is, there is a greater sales volume with low profitability level. It is provided in the case facts that the clocks are currently sold at a lower profit margin compared with the other two products. However said clocks have a greater sales volume in comparison2. This implies that fixed costs conversion to variable is not proper. As to dinette sets there is no mention about its profit margin and sales volume in the market thus this paper is not making any recommendation as to said type of product.
It is therefore clear that conversion is applicable for Claire’s Antiques for one product but not to other the product and the conversion is proper only under certain conditions as explained earlier.
To arrive at the appropriate derivation of cost, there is need to trace the relationship of the cost to product produced. If the costs vary directly with production, the same must be considered as variable cost but if they remain regardless of the level of production, the same must be considered fixed cost. But derivation of cost3 should not stop as determining what are fixed and variable costs as there is a need to continue by setting the acceptable level of fixed cost and variable in relation to expected demand for a company’s product or service and its profitability level in terms of profit margin. There must be an effort to identify the cost and reduce the same without sacrificing acceptable level of quality for a certain product.
Conclusion
It can be concluded that the converting fixed cost to variable cost is an option to a management buy the there are conditions before the same could be used. As found in this paper, conversion was advisable in case there is a low sales volume but with higher profit margin level for a certain product. On the other hand, conversion is not advised if there is high sales volume with low profitability level. To attain appropriate derivation of cost, cost must be classified first into variable and fixed and achieving a balance of the two in relation to demand of a product and its profit margin.
Works Cited
Case Study – Claire Antiques.
Vandermeulen, D., Linear economic theory, Prentice-Hall, 1971.
Footnotes
- Case Study – Claire Antiques.
- Case Study – Claire Antiques.
- Vandermeulen, D., Linear economic theory, Prentice-Hall, 1971.