Cost Behaviors: Variable Costs vs. Fixed Costs
Understanding cost behavior is a fundamental concept in cost accounting, as it explains how different types of costs change in response to variations in business activity levels. Whether a company is increasing production, expanding sales, or cutting back, knowing how costs behave can help in budgeting, forecasting, and decision-making.
In this section, we’ll explore the key categories of cost behavior—fixed costs, variable costs, and mixed costs—and how they influence overall financial performance.
Variable Costs: These are the costs that fluctuate in direct proportion to changes in production or sales volume. As a company produces more goods or provides more services, variable costs increase, and when production decreases, these costs drop accordingly. Common examples include raw materials, direct labor, and shipping costs.
Fixed Costs: Fixed costs, on the other hand, remain constant regardless of changes in production levels. These expenses are incurred even when production is at zero. Examples of fixed costs include rent, salaries for administrative staff, insurance, and depreciation of equipment. Fixed costs are important because they create a stable baseline of expenses that must be covered by revenue, regardless of business activity.
Mixed Costs: These costs contain both fixed and variable components. For instance, a utility bill may have a fixed base charge plus a variable amount that depends on usage. Mixed costs change with activity levels, but not in direct proportion like purely variable costs.
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