UnderstandingtheTerminologyofCost
Whendealingwithfinancesandbusiness,understandingtheterminologyofcostiscrucialinmakinginformeddecisions.Thisarticlewilltakeyouthroughthethreemaintypesofcosts:variable,fixed,andmixed.
VariableCosts
Variablecostsarecoststhatchangebasedonthelevelofoutput.Thesecostsincreaseasthelevelofproductionincreasesanddecreaseasitdecreases.Examplesofvariablecostsaredirectmaterials,directlabor,andcommissions.Sincethesecostsfluctuatewithproductionlevels,theyareoftenreferredtoasflexiblecosts.
FixedCosts
Fixedcostsarecoststhatremainconstantregardlessofthelevelofproduction.Examplesoffixedcostsarerent,salaries,andinsurancepremiums.Thesecostsdonotchangeevenifacompanyincreasesordecreasesitslevelofproduction.Fixedcostsaresometimesreferredtoasoverheadcostsbecausetheyarenecessarytooperatethebusiness,butdon'tvaryaccordingtooutput.
MixedCosts
Mixedcosts,asthenamesuggests,areacombinationofbothfixedandvariablecosts.Thesecostshaveafixedcomponentandavariablecomponent,makingthemdifficulttoseparate.Examplesofmixedcostsareutilitybillsandsupplies.Thefixedcomponentofamixedcostisthesameregardlessofthelevelofproduction,whilethevariablecomponentincreasesasproductionlevelsincrease.
Understandingthedifferenttypesofcostsisessentialinanalyzingbusinessoperationsandmakingsoundfinancialdecisions.Byidentifyingfixedcostsandvariablecosts,abusinesscanbetterunderstanditscoststructureandplanitsproductionlevelsaccordingly.