In order for a business manager to make good pricing decisions, budgeting, and p

Question

In order for a business manager to make good pricing decisions, budgeting, and planning decisions, it is important that he/she has a good understanding of the cost structure of their business; specifically as to classifying costs as being fixed or variable cost.

The definition of a variable cost is “a cost category that varies directly with changes in business volume or activity”; a good example would be raw materials for a steel mill.

The definition of a fixed cost is “a cost category which does NOT change based on changes in business volume or activity.” This DOES NOT MEAN that fixed costs do not vary, but rather that fixed costs do not vary BECAUSE of business volume.

Good examples of fixed costs would be a monthly business property mortgage, or property taxes, or salaried staff.

In order to properly categorize a cost as being fixed or variable, you must first decide on the metric for the firm’s business volume. For instance a steel mill, which might make different lengths and thicknesses of steel would use TONS of steel as their unit of measure; a barber shop might use “number of haircuts given”; a university would probably use “number of students or number of credit hours being taken this term”; for a business selling MANY different products, the best way to measure business volume would simply be $ of total sales or revenues [Wal-Mart, 7-11, HVAC repair business].

Question to then answer:

First, WHY is it important to properly categorize a cost as being fixed or variable?

Would you rather manage a business, most of whose costs are fixed…or most of whose costs are variable? Why?

Then, for EACH scenario 1-8 in the list below, describe:

The likely unit of measure for how the business measures business volume;

Whether the cost is fixed or variable

Why you categorized it that way?

1. Wood supplies at a furniture factory

2.Bread dough at Subway

3. Cockpit crew for an airline

4. Diesel fuel for a passenger cruise ship

5. Crew costs for a passenger cruise ship

6. Diesel fuel for a supertanker

7. Non-management employee costs at H&R Block 1/1/XX-4/15/XX

8. Snowmaking chemicals at a ski resort

Explanation / Answer

It is important to classify cost as being fixed or variable because in order to make any venture to turn into a profitable business we need to cut down the or atleast reduce the variable cost as low as possible and if we don’t know the various expenses which comes under variable cost then it would be impossible for us to decrease those expenses.

If given a chance then I’ll go for the business which have variable cost involved in it because then it’ll give me more options to make profit as I would be having “n” number of opportunity (variable cost in this case) to make profit.

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