Balance Fixed Variable Costs Essay

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Fixed and Variable Costs

In accounting, there are really two types of costs that affect business expenses: Fixed and Variable. They may be thought of in general as a system in which fixed costs form the base and variable costs ride on top, but may increase or decrease based on individual organization differences and structures (See figure 1). Fixed costs are expenses that are not dependent upon the goods or services produced by the organization, but are costs that occur on a regular basis, regardless of what the business does. In other words, these costs are "fixed" over time -- often referred to as overhead. For example, regardless of production, an organization must pay rent, utilities, insurance, etc. each and every month (Hansen, D., et al., 2009).

Variable costs, in contrast, change over time in proportion to the goods or services provided by the business. They are also known as marginal costs or operating costs and there are several components. Labor, for instance, can be a variable cost if it is in proportion to the amount of production. However, if labor is contracted or unionized, and must be paid whether there is adequate work or not, it changes to become a conversion cost. Variable costs may be best understood when looking at the costs associated with manufacturing something: the more of the product that is manufactured, the more the amount of inventory and/or raw materials necessary to make that product.

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Utilities, though, are considered to be Fixed Costs because the occur on a regular basis. However, if it takes X to simply pay for basic utilities, but when production is increased, then electricity is also increased by 40%, then a portion of the utilities are variable costs because they change in accordance to the amount of materials produced (Hansen, et al.).

For an organization to be healthy, it is necessary to balance fixed and variable costs, particularly in the 21st century global economy when almost every aspect of the business happens more quickly. To balance fixed and variable costs, experts suggest that the infrastructure should be flexible and planned on reality rather than complete projection. Supply chain management will help provide a relationship with vendors so materials can be delivered quicker and when needed through just in time inventory. Greater part time or flexible working environments will help balance labor when necessary, as will building staff slowly using part-time or….....

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