In today’s rapidly changing business environment, companies are looking for ways to remain competitive, and strategic planning is a key element of success. As businesses look to plan for the future, they must consider the concept of relevant range to ensure that their decisions are optimized for long-term success. Relevant range is a tool used to define the scope of a particular problem or decision that must be made, taking into account both the internal and external factors that will influence the outcome. It allows businesses to identify opportunities and threats within their environment that could affect their decision-making process. By understanding what is within their relevant range, businesses can make more informed decisions and plan for the future with greater accuracy and success. In this blog post, we will explore what relevant range is, how it can be used to improve decision making, and how to ensure the relevant range used accurately reflects the current conditions of the environment.
The Relevant Range (Managerial Accounting)
When can you use the relevant range?
Relevant range is essential to the following processes:
Budgeting
Budget projections are created by businesses to plan for future growth and to update shareholders. In order to do this, assumptions must be made regarding the pertinent gamut of activities they might engage in during the budgetary period. These presumptions enable businesses to calculate costs based on their fixed expenses. The anticipated profits and losses are likely to be realized as long as their operations are within the relevant range. A company’s assumption may benefit from keeping the pertinent range close to the level of current activity.
For instance, a company can create a budget that allots profit distributed to shareholders if it is planning its growth over the next ten years to share with prospective shareholders and investors. The business deducts the cost of doing business from the anticipated revenue to arrive at this calculation. The cost of labor to produce the product and the fixed cost of the warehouse used to store the inventory are then calculated. These costs likely wont change for the next 10 years. With these calculations, the company establishes the relevant range. The profit is then calculated by deducting the cost from the anticipated revenue.
Cost accounting
The managerial staff uses cost accounting as a tool to determine the total cost of doing business and to plan for future expansion. It helps calculate fixed, variable and operating costs. Managers can use this to assess whether business costs are legitimate.
There are four types of cost accounting:
Vendor discounts
Vendor discounts are the price of materials per unit. Companies determine whether the amount of materials falls within their relevant range when calculating the value of buying in bulk at a specific price range.
For instance, a clothing company plans to make 100 shirts and sell them for $10 each, bringing in $1,000. It invests $100 in 1,000 metal snaps to make the shirts. This leaves the company with $900 in profit. However, the business would spend $1,000 and lose money if it attempted to purchase 10,000 metal snaps at the same unit price of $10 per snap.
What is the relevant range?
The parameters of production or activity within which a company maintains the same fixed costs are the relevant range. Fixed costs are constant and independent of particular production rates in accounting.
Fixed costs can include:
These costs don’t change unless your company expands or contracts more than what your relevant range permits. For instance, you might produce more units one month than the previous month, but your fixed costs will typically not change. However, if you increase production to the point where you need to relocate or hire more staff, you have now outgrown your appropriate market. This implies that your fixed costs are adjusted to reflect the new rent and the new salaries. As a result, you can calculate costs when creating your budget because this establishes your new relevant range.
How to calculate the relevant range
When determining the appropriate range, keep the following in mind:
1. Determine your growth rate
Estimate your growth rate for the upcoming accounting period when determining the relevant range. This assists you in estimating any expenses you might incur to widen your relevant range. The following variables are frequently used by businesses to gauge growth rates:
2. Calculate current costs
Calculate the cost of doing business at your current rate to determine your relevant range. This requires considering both fixed costs and variable costs. Production materials are an example of a variable cost that changes depending on how much the business sells. It is not necessary for the rate of change for variable costs and production to be proportional. You might, for instance, see a 20% increase in production while only a 10% increase in variable costs.
3. Compare your costs and growth rate
Compare your growth rate to your current costs after calculating it. Find out how much production it could buy using your current costs as a guide. Then, think about how much more production you could have before your fixed costs had to go up. Your maximum growth rate remains within your relevant range if it doesn’t exceed your costs. You’ve reached the upper limit of your relevant range once your growth rate necessitates adjusting your fixed costs.
You can do the same exercise in the opposite direction. To maintain a profit, you might need to reduce your fixed costs at some point. Determine how much you can decrease your production. This is the bottom of your relevant range.
Examples of the relevant range
Here are some examples of the relevant range:
Relevant range in production
ABCMotorcycles produces 50 eco-friendly motorcycles a year. It buys 60 eco-friendly exhaust pipes in bulk for $1,000. The company’s annual sales increase by 10 units once it becomes well-known. The first year of the increase, it sells 60 motorcycles. Given that ABCMotorcycles purchased 60 exhaust pipes and sold 60 motorcycles, this still falls within relevant range.
In the following year, it sells 70 motorcycles, prompting the purchase of an additional 60 green exhaust pipes. Now the company has 120 pipes and paid $2,000. Due to the fact that its fixed costs have changed, this is outside of its applicable range. Up to 120 motorcycles can be produced per year on the new relevant range. ABCMotorcycles can continue operating within this pertinent range for an additional five years at its current growth rate. By the sixth year, the company’s 10-unit-per-year growth rate equals over 120 units sold, forcing it to raise fixed costs once more.
2. Relevant range in labor costs
Home Cooked Restaurant employs five servers to cover four sections. Out of the overall profits, which come to $1,200 per night, each server receives $200. The remaining $200 in earnings is used for other expenses like rent. One day, a fire renders two sections unusable. This reduces the total profits to $600 a night. The restaurant still needs $200 to cover the other expenses, so the amount is no longer within the acceptable range to pay five servers. It reduces its staff by three and operates within its new relevant range of two servers until the damaged sections can be repaired.
3. Relevant range in labor needs
At Direct AC, a sales team grew from three to seven people in a year. Each salesperson’s increased revenue more than covers the cost of hiring them. But the teams manager, who earns $75,000 annually, is unable to effectively oversee more than 10 salespeople at once. So, its relevant range is 10 salespeople. In the upcoming year, Direct AC will need to hire another manager to keep up with the team’s expansion, which will raise its fixed costs by $75,000. After that, the new relevant range is 20 salespeople.
FAQ
How do you calculate relevant range?
Calculate the cost of doing business at your current rate to determine your relevant range. This requires considering both fixed costs and variable costs. Production materials are an example of a variable cost that changes depending on how much the business sells.
Why is the relevant range important?
Because making the assumption that all of your costs will remain constant, whether they are fixed or variable, could lead to inaccurate projections, relevant range is crucial.
What is relevant range in CVP analysis?
The same behavior of costs within the appropriate range is one of the presumptions of CVP analysis. The relevant range depicts the level of activity that the company reasonably anticipates will exist during a specific time period. It is also known as the typical or useful range.
What is the relevant range for fixed cost?
The term “relevant range” is used in accounting to describe a normal range of volume or normal amount of activity, where the total amount of a company’s fixed costs will not change as the volume or amount of activity changes.
