Cost Behaviour is the way cost responds to the changes in volume or activity a factor in almost every decision managers will make. Managers commonly use it to analyse alternative courses of action so they can select the course that will best guarantee income for an organisation’s owners and maintain liquidity for its creditors.
Managers plan and use cost behaviour to determine how many units of products or services must be sold to generate a targeted amount of profit and have changes in planned operating, investing and financing activities will affect operating income.
Cost behaviour can be seen in Fixed Costs, Variable Costs and Mixed Costs.
Fixed Costs: Fixed Costs as the name suggests are fixed. They are fixed as in the rent for the factory, the rent for the machinery if purchased on hire-purchase, etc. These costs are fixed i.e. the number of goods produced is 0 or 10000, the costs will not change. So, the ideal is to produce as many goods as they can to decrease the amount of average fixed cost per product.
Variable Costs: Variable Costs are those costs which vary with the production. These include the cost of raw materials, the cost of hiring additional workers, the cost of power or electricity which is incremental with every extra good produced. Variable costs will increase the cost of production but, as the amount of raw material purchased increases there will be an increase in the price but at a decreasing rate.
Mixed Costs: Mixed Costs are those costs which are both fixed and variable at the same time. A proportion of the cost is fixed and the other proportion of them is variable. The examples for these include electricity, telephone and heat. In all these services there is a minimum cost which is fixed like the rent for telephone, etc and an additional cost which varies with the usage of the service.
Overhead Costs: Overheads are those costs which cannot be put under a specific category but will be put under the name. For example, an expense like repairs to the building, insurance, advertising, interest, legal fees, taxes, telephone bills, travel and utilities costs. These costs cannot be immediately allocated to the goods or the services produced. But, instead, these expenses are added to the expenses building insurance or repairs to the building expenses or building maintenance head but they cannot be put under a separate head called building repairs, expenses, etc.
Cost-Volume-Profit Analysis: Cost –Volume-Profit Analysis is an examination of the cost behaviour patterns that underlie the relationships among cost, volume and profit. The relationship is measured as
Sales Revenue – Variable Costs – Fixed Costs = Profit
Break-even Analysis: Breakeven analysis uses the basic concepts of CVP relationships. The Breakeven point is the point at which total revenues equal total costs. It is the point at which the concern starts to earn a profit. For a given investment, given level of production, the number of goods produced and the cost per head of each good will determine the Breakeven point. Knowledge of breakeven point for a product is very essential as it will give the information from which product will the company start earning profit. For example: if the breakeven point is 23,000 units and if the total market is 25,000. Then the profit will start from the 23,000th good. So, here the profit making units are the last 2,000 units. The amount of profit that the company seeks will also be determined with the help of Break-even Analysis. If a company wants to earn a profit of $10,000 with an investment of $200,000. So, the company will determine that in order to earn a profit of $10,000 how many numbers of goods it has to product.
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