Net income and cash flow conflict in accounting approaches and in their respective impacts on businesses. Net income includes any revenue earned within an organization especially as accrued from sales. However, it does not cater for the actual payments or instances of cash payments. Therefore, despite having made actual money within the transactions it cannot be used since it is not considered as cash at hand. Cash flow is money in currency form that a business receives and spends during a specific financial period. The focus however on any company’s financial management department should be on both cash flow and net income. This is because although liquid cash is necessary in warranting transactions, receivables are also an important aspect of the business (Brigham, & Ehrhardt, 2010).
The absorption costing income statement is used when the Cost Volume Profit (CVP) analysis is not important and in instances where an organization needs to calculate its manufacturing gross profit. The variable costing income statement is used to analyze CVP since the break-even point and the contribution margin are effortlessly determined from the document. Manufacturing organizations are the only firms that require two separate income statements. However, only one can be used in an organization’s operations since they have to choose one method of valuing input materials (Horngren, Datar, & Foster, 2006). This is because the two methods yield different results because absorption costing does not include fixed costs of goods not sold while variable costing method all fixed overheads are treated as expenses even for goods not sold.
There is a notable danger in accepting all offers that have a positive contribution margin. This is because the contribution margin may be positive but not high enough to surpass a company’s costs as noted by the break-even point. It is always prudent to consider fixed costs in the manufacturing process and whether the contribution thereby achieved is able to cover noted overheads for profit realization. Therefore, the sole consideration of a positive contribution is not valid in all instances unless the cost factor is also used. How positive a contribution margin is, acts as a vital element in any organization (Warren, James, & Jonathan, 2011).
The existence of high proportions of fixed costs enhances user desirability of activity based costing (ABC) methods. This is because high fixed costs are principally attributed to employee wages. ABC methods permit managers in the computation of cost per time unit in terms of capacity as well as the estimation of unit times in a given activity. This in turn saves money for the firm and creates a competitive cost saving advantage that obviously adds value to the organization’s customers (Bradtke, 2007). Activity based costing also aims at changing how costs are calculated through allocating costs to products and services according to resources they require.
Non-traceable costs are not allocated to any specific department in an organization but eventually they have to be paid for within the affected institute. This is because every cost incurred in a company has to be expensed in the profit and loss account and therefore in a bid to set it off against any incomes that may have been made. Therefore, the costs though untraceable and unallocated, end up being remunerated within the whole company (Rayburn, 2003). This happens where there are allocated budgets for every department but other costs arising that are not budgeted for hence the company as a whole has to account for them.
Bradtke, D. (2007). Activity-Based-Costing. Munchen, Germany: GRIN Verlag.
Brigham, E. F., & Ehrhardt, M. C. (2010). Financial Management Theory and Practice. New York, NY: Cengage Learning.
Horngren, C. T., Datar, S. M., & Foster, G. (2006). Cost accounting: a managerial emphasis. Hoboken, NJ: Pearson Prentice Hall.
Rayburn, L. G. (2003). Cost accounting: using a cost management approach. Boston, MA: Irwin.
Warren, C. S., James, M. R., & Jonathan, D. (2011). Financial and Managerial Accounting. Independence, KY: Cengage Learning.