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Flexibility - or Not:
The Impact of Fixed and Variable Cost
In a time of reduced defense budgets, financial managers seek to optimize
budgetary resources while allowing the flexibility to absorb such reductions.
Tom Willson explains that understanding both fixed and variable costs are
fundamental to establishing a budget’s flexibility.
BY TOM WILLSON
\
PROC + $20 M Greater of: Line Item 3 Years
\ $20 M 5 years SCN
T - 20%
H
B R O&M + $ 15 M - $ 15 M Budget A ctivity 1 Year
E E --has Many. BA 1
L S CIVPAY Sub-Activity
Lim itatio ns on
0 H Decreases
W 0 (OPTEMPO SAGs)
l
MILPAY + $ 10 M No Budget Activity 1 Year
D Congressional
Restriction
Military Construction (MILCON). Considered a fixed cost as Congress Transportation. Considered a variable cost. EOR classification does not
appropriates funding for construction items at project level. provide specific detail about what is being transported or how.
Civilian Personnel. Considered a fixed cost as previously discussed. as billpayers. Besides color of money or EOR, time is also a factor to
Because of the magnitude of the cost of CIVPAY across the federal consider. The period of greatest flexibility within a budget is at the start
government, this EOR is often the most targeted EOR for reduction. of the fiscal year. Once a dollar is obligated, it becomes a fixed cost
because it can no longer be used for any other reason. As variable cost
Military Personnel. Considered a fixed cost as previously discussed.
dollars are obligated, they become fixed cost. Over time, the fixed cost
Travel. Organizations often differentiate between travel that is mission- portion of the budget grows relative to the variable cost portion until,
essential (ME) or non-mission essential (NME). Following those at year end, the entire budget has been obligated and all dollars are
classifications, ME is a fixed cost, NME is a variable cost. This EOR now fixed cost. Because of the reduced flexibility that occurs with the
is also a favorite target for cost reduction, although often there are passage of time, budget reductions are best addressed sooner rather
exceptions/exemptions for travel related to job-required professional than later. With each passing day during the year of execution, there is
development and PCS travel. less and less flexibility.
reflects a truer impact of the reduction should use only the variable cost Defense Programs, at the Whitman School
o f Management, Syracuse University. He
dollars in the denominator. There is no change to the decrement amount in
holds an MBA from Syracuse University
the numerator. The percentage reduction using only variable cost is known
and an MSA from Central Michigan
as the effective rate or e-rate. If any portion of a budget is fixed cost, the
University. Tom is a Certified Defense
e-rate w ill be larger than the specified rate. The implication of the e-rate is Financial Manager with Acquisition
that because it more accurately reflects the ability to pay the bill using only specialty (CDFM-A). He is a member o f
variable cost, it more accurately shows the true impact on the organization. ASMC’s Leatherstocking chapter.
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