Business Costs

Fixed costs

Fixed costs are costs which do not change with the level of production. These are also called overhead costs. Fixed costs include rent, salaries, insurance, interest payments, and other ongoing expenses. These are typically ongoing monthly expenses that do not change with the level of production. These are mostly time related and are usually paid per month, per quarter, or per year. They remain fixed in the short run.

Fixed costs will affect the profitability of a company because they cannot be reduced or eliminated in order to increase profits when there is less production. This means that any time there is less demand for a product or service, the company will not be able to reduce their fixed cost in order to create more profit margins.

Variable costs

Variable costs are the costs that change in direct proportion to the level of production. These include raw materials and direct labour costs. These costs will increase as production increases. For example, if a company produces more sweaters then it will need more yarn and its variable costs will go up.

Variable costs can affect a company’s profitability in many ways. For example, if variable cost per unit is lower than the average revenue per unit then the company will have higher profitability. If variable cost per unit is higher than average revenue per unit then the company will have lower profitability. This is because when variable cost increases, average revenue per unit decreases and vice versa.

Semi-variable costs

Semi variable costs comprise both fixed and variable components. These costs remain fixed for a given level of production, time or consumption, after which these costs become variable when the set level is exceeded. For example, when sales men are paid monthly fixed salary and performance incentives, the monthly salary is firm’s fixed cost and the performance incentive is variable cost. So, put together, it becomes, semi variable cost. Another example would be  a monthly rental for phone line which constitutes a firm’s fixed cost, while call charges constitute its variable cost.

Direct costs

Direct costs are those costs that can be identified with the production of  specific goods or service. The cost that can be directly attributable to/identified with/ associated with the specific cost centre or cost object like a product, function, activity, project and so on is known as direct cost. Unlike  variable costs, direct costs are not directly related to the  quantity of goods produced or sold, however, these costs can be traced back to the  product.

Indirect costs

Indirect cost is those costs that cannot be directly assigned to/related to/identified with a particular cost centre or cost object, but they benefit multiple cost objects. It is not possible to calculate them for a single cost object. However, it needs to be apportioned over various products as well as among the different departments of the organization. It includes production, office & administration, selling & distribution costs.

Are the direct costs and variable costs same?

Although direct and variable costs are tied to the production of goods and services, yet they can have some distinct differences. Variable costs can fall under the category of direct costs, but direct costs don’t necessarily need to be variable.

Direct costs are expenses that can be directly traced to a product, while variable costs vary. Both types of costs are involved in production.