Understanding Costs

COSTS: HOW THEY BEHAVE

Understanding costs and your business numbers help with a variety of things, including:

  • Pricing of goods and services
  • Business planning
  • Cash Forecasting
  • Controlling costs
  • Understanding profitability of customers, products and services
  • Improving efficiency

If we can describe and link business activity with costs then we have a powerful insight into and understanding of costs.  These costs are

  • Fixed costs
  • Step costs
  • Variable costs
  • Semi-variable costs

Fixed costs

Fixed costs are those that accrue with the passage of time and are not affected by changes in activity level.  These will stay constant irrespective of the level of activity (miles travelled, journeys made).  The cost of car road tax will be the same whether we drive it 200 miles a year or 15,000 miles.  The same applies to insurance and MOTs.

Other costs that will be largely fixed in nature, despite how much we sell (up to a point) include:

  • Wages and salaries – fixed amounts
  • Insurance
  • Rent and rates
  • Depreciation on assets
  • Leasing charges

Variable costs

Variable costs vary/fluctuate with changes in level of activity.  Referring to car example above, a variable cost would be petrol, the total variable cost will vary and fluctuate according to the amount of mileage that we do.  Other examples of variable costs are:

  • Stock – varies according to level of sales
  • Sales commissions – varies according to level of sales
  • Overtime– varies according to number of hours worked

Stepped costs

If our business expands or contracts to a certain point then our fixed costs may alter.

The main feature of stepped fixed costs is that within a given time period, they are fixed within certain activity levels, but they eventually increase or decrease by a constant amount at various critical activity levels.

Examples of step fixed costs include:

  • Recruitment of additional supervisory staff beyond certain production levels;
  • Renting of additional storage space

Semi-variable costs

We will have some costs, which will not fit the category of fixed or variable.  Some of our costs have a fixed and variable element.  For example, our telephone costs are made up of a rental element, which is fixed, and the costs of our actual calls, which are variable.    Other examples of semi-variable costs are:

  • Gas and electricity costs
  • Photocopier rentals

The benefits of any decision-making will be improved if we can split our semi-variable costs into the fixed and variable elements – we need not concern ourselves with ‘insignificant’ amounts.

Businesses, private and not for profit operate in an increasingly changing and competitive environment. 

If you would like us to help you understand, appreciate and use your business numbers more then please contact us. We can have a cup of (virtual or real) coffee, biscuit and a chat as to how we can help.

Pro Active Resolutions- Your Accounting Solution and Business Friend

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