Proper management of a business requires that the financial analyst have a clear grasp of the concept of variable and fixed costs. Similarly, the analyst must have a clear understanding of the application of these concepts to the management of a business. This is because the variable and fixed costs have a direct influence on the production and the overall performance of a business. For instance, an increase in either of the costs will imply increased production and a decrease will definitely be followed with a decrease in production. This paper identifies and defines variable, fixed, and mixed costs. The paper also determines the effects that an increase in sales volume will have on unit fixed cost, unit variable cost, total fixed cost, and total variable cost.
Management of modern businesses has become a center of focus in the business industry. Some of the costs that are associated with the running of a business can either break or make a business venture. It is therefore important for financial analysts to understand how different costs affect the performance of a business venture. This is done to mitigate the challenges that can arise from too much costs associated with the running of a business which may in turn lead to the business incurring increased losses. As such, in managing a business, it is highly important for financial business analysts to appreciate the idea of variable cost as a vital concept. Furthermore, it is also important to know how this concept can be practically applied in the daily running of a business. This paper identifies and defines concepts related to the costs of doing business such as variable, fixed, and mixed costs.
As the company engages in the activities of doing business, it is required to spend on certain operations that are important in the facilitation of the business activities. Variable costs are costs that a business incurs in the process of carrying out its operations. These costs keep changing from time to time. The rate of change is proportionally to the operations that the business is doing. In order to get variable costs, calculations are done as the sum of the marginal costs per the total units that the business produces. Variable costs are among the most important components and vital management tools in computation of total costs that the business incurs during a financial year (Albrecht and Stice, 2010). Variable costs are also known as unit-level costs because they tend to vary with the number of units that the business produces. Normally, variable costs increase at a stable rate that is proportional to labor and capital in the business. Examples of variable costs that a business may incur include customer services, costs of operations, perishable foods, food items, utilities, wages, raw materials, and packaging (Hansen, Mowen and Guan, 2007). For an airline business, a good example of variable cost is the cost of fuel as it depends on the number of flights that are made during a particular period.
The process of doing business, a company may find that some costs are incurred whether the company has produced units or not. Fixed costs are those costs that are independent of the output within the business. Fixed costs therefore do not change with the level of activity that the business performs (Bannester, 2004). Examples of fixed costs that a business may incur include costs associated with the depreciation of business assets and the rent expense. Other fixed costs include; salary of the permanent staff, insurance premium, property fare, interest on the capital invested among others. Nevertheless, the fixed cost per unit will decrease with the increase in the production level of the business.
Mixed costs are costs that display the characteristics of both variable and fixed costs. This means that a certain percentage of this cost is constant while the rest is dependent on the level of business activities in the company. A good example of mixed cost that a business will incur is the costs associated with telephone use. In businesses, telephone services are offered by a third party, which means that the business must pay a monthly subscription fee that is constant whether the telephone is used or not (Ingram and LaForge, 2012). Additionally, there are those variable costs that are charged per the time that the telephone is used, usually a minute. Another example is the cost of water where the business may be using rented water from a water service provider. The water meter is charged a fixed subscription fee while the other cost is proportionate to the amount of water that is used and is based on the meter reading. If the business owns vehicles that transport products, the business may find that it is incurring the constant depreciation costs while the variable cost of fuel depends on the trips that the vehicles are making in the course of doing business. Mixed costs are analyzed well using cost-behavior analysis methods such as High-Low Method, Scatter Diagram Method, and Regression Analysis (Ingram and LaForge, 2012). This is important in splitting the costs into their respective variable and fixed costs.
Effects of Increase or Decrease in Sales Volume on the Various Costs
Sales volume represents the number of units that a business has sold during a particular period. Given that unit fixed cost, unit variable cost, total fixed cost, and total variable cost are all dependent directly or indirectly to the number of units produced, a decrease or an increase in the sales volume will definitely have effects on these costs (Jackson, Sawyers and Jenkins, 2008). However, certain costs like total fixed costs will not be affected by the proportionality in sales volume because fixed costs are independent of the activities that the business engages in during a particular period. The total fixed cost is the addition of pure fixed cost, like rent on business building and property taxes together with the fixed constituent of mixed costs, such as total fixed cost on delivery vehicles. This therefore represents a straight-line reduction outflow. This implies that a change in sales volume, whether increase or decrease, will not affect the total fixed costs that the business incurs in a particular period.
Consequently, an increase in sales volume means that the production has increased and therefore the unit fixed cost will be unchanged with the increase in the sales volume. On the other hand, the unit variable cost will increase with increasing sales volume because of the need for more capital and labor for production of many units. A decrease in the sales volume will have inverse effect to the unit variable costs because the cost of labor and capital will be reduced. Similarly, an increase in sales volume will increase the total variable costs since the business will be spending more on production. This is because more customer services, costs of operations, perishable foods, food items, utilities, wages, raw materials, and packaging will be required to produce the extra units. Increasing sales volume will therefore increase the variable costs and some parts of the mixed cost (Jackson, Sawyers and Jenkins, 2008). However, a decrease may not have the same effects on the variable and mixed costs that a business incurs in a particular period.
From the above analysis, variable cost, fixed cost, and mixed cost that a business incurs in the course of carrying out its operation are vital financial tools that are useful in controlling how the business does its activities. A financial analyst must therefore consider the different costs that a business is incurring with a view of establishing ways to control or reduce the costs that are associated with doing business if the business is to remain profitable in a highly competitive environment. Similarly, sales volume is a good indicator of how well the business is doing. However, an increase in sales volume does not necessarily mean that the business is making profits and therefore consideration should be placed on other costs to ensure that they do not escalate to the point whereby the sales volume are high and yet the business in not making any profit.