Question

Why is it important for managers to understand cost behavior?

Answer 1

Answer) Cost behavior deals with understanding the pattern of the cost and changes in the cost due to change in the organizational level of activity. In order to study cost behavior, we divide the total cost into two parts: Variable cost and fixed cost. Variable cost varies with the level of production. For example, the cost of raw material. It is also known as a direct cost. Whereas Fixed cost remains fixed and doesn't change with the level of production. Cost behavior is the study of the pattern of both the costs due to various strategic changes in the business. It is very important for the manager to understand the cost behavior. Some of the important reasons are as follows:

1. Forecasting of cost in long-term: Changing pattern of cost can have the adverse effect on the profitability of the business in future. So, understanding the present cost behavior helps to predict the future cost and helps intake control measures.

2. Budgeting and reporting: Budgets are made to keep the check on the cost pattern and to keep expenses in control. Studying the cost behavior helps to understand the pattern of fixed cost and variable cost in order to set the budget for the future activities.

3. Maintaining the desired level of profits: Managers need to understand the cost behavior in order to keep the check on the various costs involved in the production. In order to earn the desired profit, understanding cost behavior is necessary for the managers.

4. Decision making: Cost behavior plays the important role in business to take the various decision. Variable cost is the cost that can be controlled and helps business managers to take any decision such as make or buy decision, shutdown or continue decision, selling in the domestic market or international market, etc.

5. Reducing wastage: Understanding the pattern of cost helps to reduce various wastage of resources and maximizing the utility of the production process. Production managers study the various contents of cost like material costing, labor costing in order to prevent wastage of materials and labor time.