Business incur two kinds of operating costs — fixed costs and variable costs. Fixed costs do not vary with output, while variable costs do. i.e., variable costs increase with output but fixed costs broadly stay the same. Fixed costs are sometimes called overhead expenses. They are incurred whether a firm manufactures 100 widgets or 1,000 widgets. In preparing a budget, fixed costs may include rent, depreciation, and supervisors' salaries. Manufacturing overhead may include such items as property taxes and insurance. These fixed costs remain constant in spite of changes in output.
Variable costs, on the other hand, fluctuate in direct proportion to changes in output. In a production facility, labor and material costs are usually variable costs that increase as the volume of production increases. It takes more labor and material to produce more output, so the cost of labor and material varies in direct proportion to the volume of output.
For many companies in the service sector, the traditional division of costs into fixed and variable does not work. Typically, variable costs have been defined primarily as "labor and materials." However, in a service industry labor is usually salaried by contract or by managerial policy and thus does not fluctuate with production. It is, therefore, a fixed and not a variable cost for these companies. There is no hard and firm rule about what category (fixed or variable) is appropriate for particular costs. The cost of office paper in one company, for example, may be an overhead or fixed cost since the paper is used in the administrative offices for administrative tasks. For another company, that same office paper may well be a variable cost because the business produces printing as a service to other businesses, like Kinkos, for example. Each business must determine based on its own uses whether an expense is a fixed or variable cost to the business.
In addition to variable and fixed costs, some costs are considered mixed. That is, they contain elements of fixed and variable costs. In some cases the cost of supervision and inspection are considered mixed costs.
|Fixed cost||Variable cost|
|Introduction (from Wikipedia)||In economics, fixed costs are business expenses that are not dependent on the level of goods or services produced by the business.||Variable costs are expenses that change in proportion to the activity of a business. Variable cost is the sum of marginal costs over all units produced. It can also be considered normal costs.|