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

Variable costs, as the name suggests, are the costs that are directly proportional the level of the output in a production. They are broken down by components that directly impacts the production level. For example, rent of a factory is not impacted by level of production and hence it is not variable cost. However, direct labor cost, raw materials, utility, sales commission, etc. increase as the level of output increases. As a result these are considered variable costs.

Payback period is the duration that is required to recover the investment made in a project. In the beginning of a project, there is usually a capital investment. Through operations, the cost of investment is usually covered over a certain period. This period is called the payback period.

Fixed costs are certain costs incurred in operation irrespective of the level of output/production. For example consider the rent for the facility, full time employee’s salaries, etc. are incurred whether we produce at 100% capacity or at 10% capacity. These costs remain the same. Such costs are fixed costs. They do not vary depending on the output like variable costs.

Three key reasons to keep a good record on a daily basis are

1. Preparation of financial statements
2. Track tax deductible expenses
3. Monitor the operational metrics