Income allocation refers to deciding officially the area of business operation that should be given a particular share of money in a particular way. Income allocation is used in the determination of savings, investments, and expenses. The purpose of this project is to give students a clear expectation of what they will learn on this particular financial topic. This essay explores the objectives and information related to savings, investments, fixed expenses, and variable expenses topics to guide students on a finance lesson.
Savings/Investments
Listed Objectives
The purpose of this lesson is to:
Understand what is savings/investments
Types of savings accounts/investments
Saving vs. investing
Investing vs. speculation
Information and Resources
Understanding Savings/Investment
Savings is the amount of money that an individual is left with after deducting consumer spending from disposable income in a given period. It represents the net surpluses that a person/household has when expenses have been paid. Cash and bank deposits are some of the ways of keeping savings. To grow savings, investment is made, which involves putting money at risk. People usually save for various reasons such as education, retirement, vacation, or buying a car/house. People also save to address a future emergency. People who are unable to save are at great risk of falling into bankruptcy or debt in case of an emergency.
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On the contrary, investment refers to an item or asset that has been acquired with the aim of generating income or appreciation. A rise in the value of an item of a period is referred to as appreciation. People make an investment to use it to generate wealth in the future. Investment involves the use of money now to acquire an asset with the hope of earning more in the future. Examples of investments include the purchase of real estate, stocks, or bonds. Alternatively, investment also involves the acquisition of a property to produce goods and services. Besides, pursuing education can is also considered a future investment.
Types of Saving Accounts/Investments
Saving accounts accessible in banks are of different types with different features. They include:
Savings Account- Savings account pays interest for cash that is unnecessary for everyday expenses but accessible in an emergency. Deposits to this account can be made physically at the bank or online using a cellphone. Online savings account usually pay higher rates of interest.
Checking Account- This account offers the ability to use debit cards or write checks using money from an individual's account. Besides, individuals using this account have easy access to funds with no monthly fees. Interests on this account are higher than on a savings account.
Money Market Account- it is an interest-bearing account at a credit union or bank. It pays a higher interest rate compared to a saving account with a debit card and check-writing privileges. However, the account has more restrictions compared to checking accounts.
Certificate of Deposits (CDs)- A CD reduces access to cash for a given time with a high-interest rate. If an individual withdraws money from a CD before the agreed term is over, they may incur early withdrawal penalties.
There are various types of investment, including:
Stocks- They include shares and equities. The purchase of stock involves the purchase of ownership of a company.
Bonds- Purchase of bonds such as corporate, municipal, and treasury bonds involves lending money to an entity with the aim of getting interest payment.
Mutual Funds- This refers to an investment that a pool of individuals makes in different companies. This type of investment reduces risks associated since investment is diversified.
Retirement Plan- it is an avenue of making an investment by buying stocks and bonds with the advantage of withdrawing money without paying taxes. Risk is the same as purchasing an investment outside the retirement plan.
Option- It is the ability to buy or sell an item at a given price during a particular time. The risk with this investment is a reduction in the stock value, which may lead to loss.
Commodities- Producers and buyers are interested in placing a financial stake in commodities. The risk associated with commodity investment is that prices can rise up or down sharply due to sudden events.
Savings vs. Investing
Investing involves risking money for loss with the expectation of a positive return after a given time. Savings is 'safe' from loss of money. Besides, savings are highly liquid and readily available for use. Investments, on the contrary, have to be converted into liquid cash first through the sale. Conversion to liquid cash may take a lot of time, and it involves transaction costs. Also, investment involves a long period to allow money to appreciate. Savings are used to cater to an emergency, whereas investment is used to cater to long-term goals. Investments can be classified as growth investment or income investment, while different types of savings are offered in various financial institutions.
Investing Vs. Speculation
Investing entails buying items with the intention of keeping them for the long term. In contrast, speculation entails an attempt to capitalize on inefficiencies in the market to make a profit in a short time. Investors desire to build and increase the number of assets over time, while in speculation, ownership is not the aim. Speculation is not part of traditional investing, even if it involves making informed decisions. The speculation involves huge risks compared to traditional investing.
Fixed Expenses
Listed Objectives
The objective of this lesson is to:
Understand what are fixed expenses
Ratios
Treatment of fixed expenses in accounting
Information and Resources
Understanding Fixed Expenses
Fixed expenses are business costs that do not change irrespective of the decrease or increase in the business revenue or output. They are the expenses that a company has to pay without regard to any individual business activity. Together with variable expense, fixed expense forms part of the total costs. However, shutdown points can be used to reduce fixed expenses. Fixed expenses can influence any business's profitability, so they should be considered in decision-making. The proportion of fixed expenses that a company may incur depends on the industry they are located in. Since fixed expenses are the base costs of operating a business, they are created by schedules and contract agreements. Examples of fixed expenses include depreciation, salaries, rent payments, insurance, interest expenses, and property taxes.
Ratios
There are three types of ratios associated with fixed expenses:
Fixed cost ratio- It is a simple ratio that divides fixed expenses based on net sales to determine the proportion of fixed expenses incurred in the production process.
The fixed-charge coverage ratio is a solvency metric used to determine a company's ability to pay its fixed expenses.
The breakeven analysis involves using fixed and variable expenses to determine the level of production where expenses are equal to revenue. Breakeven analysis forms an essential part of cost structure analysis.
Break-even level= Fixed expenses / (selling price- variable expenses)
Breakeven analysis is important during decision-making concerning fixed expenses. Besides, it influences the price to be charged on sales.
Operating leverage- It is influenced by the proportion of fixed expenses to variable expenses. A higher fixed expense leads to a corresponding increase in the operating leverage. As a result, high operating leverage leads to higher profit.
Treatment of Fixed Expenses in Accounting
Fixed expenses are associated with overhead costs and operating costs. Fixed expenses are regarded as indirect costs of production. Although fixed expenses are not incurred directly during production, they form a huge part of production costs. As a result, fixed expenses depreciate over time. In addition, sunk costs may be treated as fixed costs, but not all fixed costs are treated as sunk costs. Unlike fixed expenses, sunk costs cannot be recovered.
Variable Expense
Listed Objectives
Understanding variable expense
Variable expense vs. fixed expense
Impact of variable expense on profitability
Variable cost vs. marginal cost
Information and Resources
Understanding Variable Expense
A variable expense is an expense that varies with the company's production or sales. Depending on a company's sale or production volume, a variable expense may either increase or decrease. Examples of variable expenses include manufacturing costs incurred due to packaging and raw materials, shipping expenses, and transaction fees which increase or decrease depending on sales. The variable is a constant amount on a particular unit produced. Low production translates to lower variable expenses. Other examples of variable expenses are direct labor costs, sales commission, utility costs, and raw materials costs. Variable expenses can be treated as short-term costs since they can be adjusted very quickly.
Variable Expense vs. Fixed Expense
Variable expenses are related directly to the cost of producing a product, whereas fixed have no such relationship. Variables expenses are included in the cost of goods sold, while fixed expenses are not usually included. An increase or decrease in the level of production may affect variable expenses, while fixed expenses are not affected by fluctuation in sales and production. Variable expenses are difficult to predict but are easier to adjust than fixed expenses which can be predicted easily. A semi-variable expense is a cost that falls between variable and fixed costs. Semi-variable expenses comprise a mixture of variable and fixed components.
Impact of Variable Expense on Profitability
Variable expenses increase when a business raises production levels to meet the existing demand. However, an increase in variable expenses at a higher rate than the profit earned may reduce the business's profitability. Besides, an increase in variable expenses may influence the ability of a company to achieve economies of scale.
Variable Cost Vs. Marginal Cost
Marginal cost refers to the cost needed to produce one additional unit. When determining marginal costs, the variable expense is taken into consideration. As a result, variable expenses influence the amount of marginal cost incurred during production.
Conclusion and Other Resources
Saving and investment may sound similar, but from a financial perspective, they have huge differences. Savings are used to cater to an emergency while investments address long-term goals. On the other hand, expenses are divided into fixed and variable components. However, semi-variable expenses can be classified as those expenses that are neither fixed nor variable. Variable expenses change depending on the level of business activity, while fixed costs remain constant over time. After the lesson, a student is expected to understand the meaning of savings, investment, fixed and variable expenses, and other related concepts. Other resources with information on the above topics can be found on SEC.gov, Econlib, and Investor.gov websites.
