Planning and decision making are two key areas of management, an understanding of what our costs are and how they behave under certain conditions is of crucial importance to the decision making process.
Costs can be seen from the perspective of how they behave, react and fluctuate according to organisational activity; this is a very powerful management tool. In this context costs are either
- Fixed costs
- Stepped fixed costs
- Variable costs
- Semi-variable costs
Fixed costs are also called non-controllable costs and they remain the same whatever the level of activity that an organisation does over a period of time For example, the cost of our car road tax will be the same whether we drive it 200 miles a year or 15,000 miles. The same applies to insurance, purchase price, radios etc.
Other costs that will be largely fixed in nature, despite how much we sell (up to a point) include:
- Wages and salaries – fixed amounts
- Rent and rates
- Depreciation on assets
- Leasing charges
If a business expands or contracts to a certain point then fixed costs may alter.
Stepped fixed costs
These are fixed over a range of output and then suddenly increase in one big jump. Example: a staffing level of up to 20 people may only require one foreman but, if the staff level is more than 20, an extra supervisor will be needed.
Variable costs are also called avoidable/controllable costs and fluctuate according to activity
If we refer to our car example above then a variable cost would be petrol, which will vary according to the amount of mileage that we do. Other examples of variable costs are:
- Wages and salaries – paid on the basis of piecework, hourly rate etc.
- Sales commissions
- Postage and stationery
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 – Note there is no need to be concerned about ‘insignificant’ amounts.