Cost behaviour analysis: fixed versus variable costs

Posted on Aug 06, 2023 at 10:08 PM

Cost behaviour analysis (cost behaviour analysis) is a management concept that helps departments understand the mechanism for changing industrial costs according to the company's applied behaviour, i.e. according to changing production level and activity, including fixed, direct and indirect variable costs, as well as its role as assisting in planning, making important decisions and censoring the work of companies.

The following article provides the possibility of identifying those costs and how to reduce them while demonstrating how cost analysis affects decision-making and explaining some of the techniques and methods of cost behaviour analysis; follow with us.

What are the costs involved in cost behaviour analysis?

Any company, whatever the nature of its operation, must bear three important main types of costs, fixed costs, and variable costs, while some expenses combine the former named mixed costs, as follows:

• Variable costs:

These costs describe any elements or expenditures that change with the changing volume of production or the number of goods or services provided, including the number of raw materials, packaging, employment in utilities, and other direct expenditures related to the production and manufacturing process, that is, they increase and decrease the volume of production and relate to changing sales volumes.

Calculating these costs by multiplying the production quantity by the price of each production unit, for example, a factory produces an item cost product of $2 per piece, case the factory does not make any product that will not have a variable cost. Still, if it produces 500 products, its variable cost is $1,000, and so on.

The most crucial point to note here is that these costs vary from industry to industry, so when comparing the prices of two companies, those companies must be operating in the same labour market.

For example, comparing a car manufacturer's costs can only be done with an electronic device manufacturer if it is possible to study and compare both companies' products.

• Fixed costs:

They are costs that sustain themselves without getting affected by the volume of production or the number of goods and services provided by the company. Thus, avoiding cannot be done by companies and include rental expenses, financial insurance, taxes, and other indirect financial expenses, i.e. unrelated to the production process.

For example, the previous company suppose it hires a machine to produce the product for $ 100000 per month, whether it uses that machine and produces 1 million products per month or stays idle and produces no effect; in either case, the company must pay the same agreed value.

According to cost behaviour analysis, revenue must improve for the company to achieve parity and balance when fixed costs increase. Because the variable expenses, no matter how much they grow, remain constant from the investor's point of view, they cover themselves. But fixed costs would affect the company's net profit according to the number of units produced, As production increases.

For example, renting a factory at $10,000 per month and producing 1,000 products per month, according to which the breakdown of the fixed cost of rent over the number of products is $10 per product. In comparison, if it produces 10,000 products, the value drops to $1 per month, the company's net profit has increased.

• Mixed or semi-variable costs:

Costs that combine variable and fixed cost characteristics because they contain both; for example, telephone invoices are mixed because they have set costs such as subscription fees and taxes, and other variable costs such as monthly consumption volume.

These costs could be more helpful in their initial form, so they get divided into fixed and variable components using cost behaviour analysis techniques that we will learn about later.

How can changing costs get reduced in the business world?

As mentioned earlier, fixed costs are uncontrollable and minimised, but businesses can control variable costs and try to minimise them through some changes within the workflow.

For example, more significant quantities of products can get produced with the same amount of raw materials provided the quality of the products is not affected, and the development of manufacturing and production techniques through modern and sophisticated machines can reduce costs.

Furthermore, in the new world based on artificial intelligence and technology, management should try to conduct some different analyses and assessments to look for more efficient improvement opportunities to reduce some variable costs during operating processes such as utilities, employment, and implementation of appropriate measures within the scope of the project. You can study accounting for managers course in Istanbul that helps you to do this.

What are the most popular cost behaviour analysis techniques?

The study and analysis of cost behaviour can get carried out through various techniques and methods, including:

• High-Low method:

One of the most popular management accounting methods used to divide mixed costs into fixed and variable; the levels of activities related to variable costs get classified, and the management collects and records various data, such as working hours, machinery working hours, number of units produced, etc., and corresponding total cost figures (mixed cost).

The Department analyses cost behaviour in this way so that only two data doubles from the data collected: the threshold and the threshold for obtaining inputs. These inputs enter into a linear mathematical relationship calculating average variable costs (b) and total fixed costs (a):

y = a + bx

Where (x) is the activity level and (y) is the total costs.

The previous function is to figure out how to determine the project budget and estimate the cost by counting all the total costs at any level of activity; even though the previous relationship is easy to understand but it is not very reliable as it takes a higher and lower limit than the approved data and ignores the rest of the information.

• Scatter graph method:

From graphical techniques to dividing the components of mixed costs, the analysis gets done so that the activity level gets charted on the horizontal axis and the corresponding total cost on the vertical axis, and the chart gets drawn through consideration.

After completing the chart, each unit's fixed and variable costs get estimated so that the line intersection point with the vertical axis gets set. In contrast, the average variable price is the tilt of the line. This method must be applied with great precision based on consideration, not mathematical relationships.

Concluding, 

Cost behaviour analysis is a mathematical or graphic analysis of cost behaviour used to measure total costs against the level of corporate activity for different purposes: fixed, variable or mixed.