Managing Fixed and Variable Costs: Microsoft & Wal Mart

agenda Definitions Variable costs Operating leverage Supporting evidence Total cost and units produced Minimizing costs and improvement recommendations

Definitions Fixed cost - A fixed cost is a cost that does not change with an increase or decrease in the amount of goods or services produced or sold. Fixed costs are expenses that have to be paid by a company, independent of any business activity (Investopedia, 2018). Variable cost - A variable cost is a corporate expense that varies with production output. Variable costs are those costs that vary depending on a company's production volume; they rise as production increases and fall as production decreases (Investopedia, 2018). Operating leverage - Operating leverage is a measurement of the degree to which a firm or project incurs a combination of fixed and variable costs. A business that makes sales providing a very high gross margin and fewer fixed costs and variable costs has much leverage (Investopedia, 2018).

Variable Costs Variable Cost Component - $373B Fixed Cost Component - $109B Variable Costs - 77% Fixed Costs - 23% Walmart Variable Costs Component - $34B Fixed Costs Component - $33B Fixed Costs - 49% Variable Costs - 51% Microsoft Managing Fixed and Variable Costs for Organization In the financial year ended 31st January 2018 Walmart had a variable cost component of $373,396 Million made up of cost of sales $373,396 Million. The fixed expenses component totalled$108,840 made up of operating, selling, general and administrative expenses totalling $106,510 and interest charges of $2,330. In proportion to total costs, variable costs make up 77.4% and fixed cost make up 22.6%. These proportions show that Walmart has a high variable costs and low fixed costs. In the financial year, ended 2017 Microsoft Corporation had a variable cost component of $34,261 Million made up of product cost of $15,175 and service and other costs of $19,086 Million. The fixed cost component totalled $33,057 Million made up of research and development cost $13,037 Million, Sales and marketing expenses $15,539 Million and general and administrative expenses $4,481 Million. Proportionately the variable cost accounted for 51% and fixed costs accounted for 49%. This analysis shows that the Microsoft Corporation has low variable costs and high fixed costs (Microsoft Corporation, 2017). Although Walmart has, the biggest total cost it has a low level of fixed costs, which means it, has a relatively low operating leverage. Merchandise cost represents the biggest cost for Walmart. This can be explained by the fact that for every product Walmart sells it has to pay for the supply of that product, therefore a large proportion of Walmart’s costs rise and fall in direct proportion to revenue therefore Walmart has better control over its costs. This flexibility means that Walmart is a less risky business (Wallmart Inc., 2019). In contrast, a large portion of Microsoft Corporation’s cost is fixed. The fixed costs component consists of research and development as well as marketing costs. This state of affairs is explained by the fact that the corporation develops products and markets them thus the cost are incurred whether the corporation sell one or twenty million of its products. Therefore, the company has to sell enough products to cover the overheads as each unit of sales contributes to cover the overheads. The Microsoft Corporation can be said to have a high operating leverage, which makes it a risky business in times of low sales volume (Brigham & Ehrhardt, 2014; Healy & Palepu, 2013).

Operating Leverage Microsoft Walmart High fixed cost Low fixed cost Low variable cost High operating leverage Walmart Low fixed cost High variable cost Low operating leverage Real-Life Examples of Operating Leverage Microsoft Operating Leverage The best way to explain operating leverage is by way of examples. For example, a software maker such as Microsoft. The bulk of this company's cost structure is fixed and limited to upfront development and marketing costs. Whether it sells one copy or 10 million copies of its latest Windows software, Microsoft's costs remain basically unchanged. So, once the company has sold enough copies to cover its fixed costs, every additional dollar of sales revenue drops into the bottom line. In other words, Microsoft possesses remarkably high operating leverage. Walmart operating leverage By contrast, a retailer such as Wal-Mart demonstrates relatively low operating leverage. The company has fairly low levels of fixed costs, while its variable costs are large especially for merchandise. Because Walmart stores pay for holding the items they sell, the cost of goods sold increases as sales increase. Therefore, Walmart stores have low operating leverage. Merchandise inventory represents Wal-Mart's biggest cost. For each product sale that Wal-Mart rings in, the company has to pay for the supply of that product. As a result, Wal-Mart's cost of goods sold (COGS) continues to rise as sales revenues rise.

Evidence that Supports our Findings A fixed cost is a company expense that does not change when the quantity of a company's output changes. Therefore, fixed costs are not zero when production is zero. Direct Labor may not be a variable cost if labor is not added to or subtracted from the production process as production volumes change. This situation arises when a production line must be staffed, irrespective of the amount of production volume. A company with a high proportion of variable costs can usually generate a profit at a relatively low sales level, since there are few fixed costs that must also be paid for in each accounting period. A variable cost is a company expense that varies in direct proportion to the quantity of a company's output. Unlike fixed costs, which are not contingent on output, variable costs increase or decrease depending on a company's production volume; they rise as production increases and fall as production decreases. The cost of direct materials goes up in conjunction with increases in production volume. Overhead is not a variable cost, since overhead costs will be incurred, irrespective of production levels. For example, both rent and machine depreciation, which are overhead costs, will be incurred even if there is no production activity. Variable Cost (2017), Accounting Tools The variable cost concept can be used to model the future financial performance of a business, as well as to set minimum price points. The most common variable costs are: Direct materials, since the cost of materials are charged to expense when the associated products are sold. Commissions, since the sales staff earns commissions when sales transactions are completed. Billable labor, since wages associated with billable hours are charged to expense when the associated sales transactions are completed. Piece rate labor, where employees are paid based on the number of units produced. Credit card fees, where a fee is not incurred unless a customer uses a credit card to pay for a purchase. Utility costs, which increase as production and/or employee headcount increase. Variable Cost (2017). Accounting Tools.

Total cost and units produced Through these two graphs we can see the growth, and hiccups of each company.

references Brigham, E. F., & Ehrhardt, M. C. (2014). Financial management 14th ed. Mason, OH: South-Western Cengage Learning. Healy, P. M., & Palepu, K. G. (2013). Business analysis valuation: Using financial statements. Cengage Learning. investopedia.com/terms/o/operatingleverage.asp Microsoft Corporation. (2017). Microsoft Annual Report. Microsoft Corporation. Retrieved from https://www.microsoft.com/investor/reports/ar17/index. html Variable Cost (2017). Accounting Tools. Retrieved from https://www.accountingtools.com/articles/2017/5 /8/variable-cost Wall-mart Inc. (2019). Wallmart Annual report. Wallmart. Retrieved from http://s2.q4cdn.com/056532643/files/doc_financi als/2018/annual/WMT- 2018_Annual-Report.pdf