Page 147 - Finance for Non-Financial Managers

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Finance for Non-Financial Managers
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Fixed and Variable Expenses in the Factory
In any department of every company, including the manufactur-
er’s shop floor, there are costs that do not change from day to
day and there are costs that are changing constantly, depending
on the company’s level of activity. Understanding costs that
change and those that don’t is important to the manager’s abili-
ty to manage the costs for which he or she is responsible.
Costs that essentially remain unchanged even though the
business increases its volume of sales are called fixed costs.
Such costs may be more easily predicted and managed,
because they stay pretty much the same. An example is the
rent on a building that is occupied under a long-term lease. For
the most part, that monthly lease payment will remain
unchanged for the life of the lease, predefined increases aside.
Another example is depreciation expense on an asset, which
will remain constant until the asset is removed from service,
assuming it lasts as long as intended.
Costs that increase in direct relationship to sales volume are
called variable costs. For example, a 10% increase in sales will
result in a 10% increase in variable costs. You can see that
direct materials and direct labor would be variable—the more
units you make, the more of those costs you would incur.
Packaging materials used in shipping the finished goods would
also vary with production levels.
Costs that increase in relation to sales but at a slower pace,
for example 5% for each 10% increase in sales, are said to be
semi-fixed costs, meaning they have aspects of variable costs
and also aspects of fixed costs. For example, a manufacturing
scrap pickup service might accept larger amounts of scrap
without raising its prices for pickup until it needs to send a larg-
er truck and two operators. Then it might increase the price and
keep it fixed for a while, until the larger truck can no longer haul
more scrap away. The cost over time becomes semi-fixed as
sales, and therefore manufacturing scrap, increase.
We try to label every cost element as either fixed or variable