Question

• What are variable costs? How are they broken down?

• Explain the concept of payback period.

• Discuss the concept of fixed costs. How are they different from variable costs?

• Give three reasons to keep good records every day.

Answer 1

1. Variable Costs:

As the name suggest, variable costs means the costs which keep changing/varies. These costs change with the change in production. Sometimes variable costs remain unchanged per unit, and thus they increase with the increase in the quantity of the production and vice versa. These costs vary with production volume. Examples of Variable costs: Raw Material Cost, Packing & Shipping expenses, Electricity of the Factory, Worker's Wages and so on. These are basic expenditures which are directly associated with the volume of production.

Breaking Down Variable costs:

Say here Total Variable cost of a product is $20,000 in which $10,000 is raw material cost, $ 4,000 is shipping and packing cost and $6,000 are wages. Total is $ 20,000. Lets say the production units are 5000 pcs then variable cost per unit would be:

Variable Cost Per Unit: $20,000 /5000 pcs = $ 4 per unit

Suppose production's volume gets increased to 10,000 units then variable cost per unit would get decreased:

VC Per Unit = $ 20,000 / 10,000 pcs = $ 2 per unit

It can be said that variable costs gets decreased with increase in the production units and vice versa.

2. Payback Period:

It is a formula used in capital budgeting. Payback Period means the time/years/months in which the project would pay back its initial investment's cost to investor or when the cash flows reach to that value which when accumulated, equates to initial investment's amount.

Payback Period Formula (When inflows every year are same):   Initial Investment Cost/ Total Outflow

   Inflows Every year

3. Fixed Costs: These are costs which are done once but they give benefits for a long period of time. These are sort of one time costs. Like buying a machinery is a fixed cost. A company buys machinery for a long period of time. Machinery can not be bought every year. Fixed costs are huge in nature so they are not incurred often but are done once in a while.

Examples of Fixed Costs: Buying Land building, Machinery, technology, advertisement etc.

Difference between fixed and variable costs:

1. Fixed costs are done once in a while and they are huge in nature. Variable costs are done according to production need/units.

2. Fixed costs remain unchanged throughout the life of the company but variable costs vary with the variation in the production of the units.

3. Fixed costs are incurred for future needs of the company but variable costs are done for the present production volume.

4. Three Reasons for Good Record Keeping Per Day:

(1) Control Over expenses: A company can control its unnecessary expenses by noticing its daily record checks.

(2) Planning for Future Actions: A company can plan its best future actions by keeping good records. It can plan future expenses, make budget to buy fixed assets.

(3) Implementation of new policies: Records are written picture of actions taken by a company. When the record checking is done and mistakes are resolved by record check and then the records help implement new strategies.