Any money a company spends while making its products or providing its services is considered a cost. Value at acquisition is the total of a company's expenditures on goods and services. When manufacturing their wares, businesses face two primary categories of expenditures: variable costs and fixed costs.
All business expenditures that vary with output and revenue are considered variable. This suggests that variable costs climb with increased output and decline with decreased output. Examples of variable costs are wages, utilities, commissions, and supplies.
Contrarily, fixed costs don't change no matter how much or how little a business generates. Rent, property tax, insurance, and depreciation are fixed operating expenses that are not directly related to a company's operations.
Variable Costs
Costs incurred by a business that is directly proportional to the volume of output constitute what are known as variable expenses. The proportion of a company's expenses that change as a function of output is known as its variable cost ratio. Variable costs rise as manufacturing volume rises. However, if production levels are reduced, variable expenses will also decrease. Above, we listed some common types of variable expenses:
- Labo
- Commissions
- Packaging
- The cost of utilities
- Essential Manufacturing Ingredients
Multiplying the production volume by the variable cost per unit of output yields the total variable cost. Let's pretend ABC Company sells their ceramic mugs for $2 apiece. The corporation will incur $1,000 for every 500 units it manufactures.
Fixed Costs
Some expenses are always incurred, regardless of whether or not any products or services are produced. A business can't get away from paying its fixed expenses. Unlike variable costs, which rise and fall with changes in output, fixed expenses remain constant regardless of how much or how little a firm produces.
Lease and rent payments, property tax, some wages, insurance, depreciation, and interest payments are all examples of fixed expenses. Let's utilize the identical scenario as before to illustrate.
Take Mug Manufacturing Company ABC, for example, and assume that the monthly rental of the equipment it uses to make mugs costs a set sum of $10,000. The monthly rental fee for the machine is $10,000, regardless of whether or not the firm makes any mugs during that time.
Do Marginal Costs Equal Variable Costs?
The phrase "marginal cost" describes the increased costs incurred by a company due to the creation of an additional unit of output or the acquisition of a new client. Since the cost of making an additional unit of output rises by the same proportion each time, we refer to this as an incremental cost, synonymous with the term marginal cost.
Because they are naturally incurred during manufacturing, variable costs might be considered marginal. 4 The total cost of production includes a marginal cost because variable expenses vary with output.
Are Fixed Costs Considered Sunk Expenses?
Money that has already been spent is called a "sunk cost" because it is no longer an option. Although it's possible to classify sunk costs as fixed, not all fixed expenses meet the criteria. 6 In the case of resale ability, a piece of machinery that an organization buys is not a sunk cost because it may be recovered from the initial investment.
How Do Semi-Variable Costs Differ from Fixed Costs?
In addition to "semi-fixed" and "mixed" expenses, the term "semi-variable" is also used. Both fixed and variable parts make up these costs. After a certain threshold of output, they become a moving target. There is no way to avoid fixed costs, even if manufacturing stops. Since fixed costs occur regularly regardless of manufacturing output or activity levels, they may be easily distinguished from variable costs.
How Can Businesses Cut Variable Costs?
Businesses may cut their variable expenses in a variety of ways. Increasing productivity while maintaining material consumption might result in significant savings, assuming product quality is maintained. Creating a new manufacturing method, which may involve using new or enhanced technical processes or machines, can aid in lowering variable costs.
To the extent that this is not practicable, management should examine the process to identify areas for efficiency and improvement that might lead to a reduction in variable costs, such as those associated with utilities and labor.
Summary
a business must earn more revenue than it spends on fixed costs, requiring greater effort in product development and marketing. This is because these expenses crop up often and don't fluctuate much over time. The effect of fixed expenses on a business's bottom line might vary independently of the number of items it manufactures, whereas variable costs are more likely to stay constant.
Spreading the expense of a larger quantity of items across the same set amount reduces their per-unit price. Increasing output and decreasing expenses is one method a business may take advantage of economies of scale.
