When calculating production costs, there are several essential cost components, namely variable costs and fixed costs. Both of these cost components become important in calculating production costs because these components will affect the production costs as well as the profits of the company. Therefore, this article will provide the reader’s information about fixed costs and variable costs in calculating the production costs.
Calculating variable costs and fixed costs will certainly take a long time. However, there is an easy way to calculate these two cost components. This strategy involves the use of an Accounting system. To make the accountant’s life easier, this system will automatically calculate both cost components. Furthermore, this system will deliver accurate and real-time financial statements.
Table of Content:
Table of Content
Variable Costs Definition
Variable costs are company costs that can change according to the business production activities. In other words, variable costs can increase or decrease depending on the volume of production that the company does. When the company’s production increases, the variable costs will rise. Meanwhile, if the company’s production decreases, then variable costs will drop.
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Variable Costs Function
As one of the important cost components in calculating production costs, variable costs certainly have several functions. Here are the functions:
Helping the company in short-term decision-making
With these costs, a company will be able to make some decisions in the short term. For example, if a company receives an urgent production order. The company can calculate production costs and prices with variable costs.
Helping the company with cost control
The company can separate this type of cost with fixed costs from the company’s financial statements. So that the company can focus on fixed costs behavior. This will be easier by using an integrated accounting system.
Make it easier for the company to determine short-term profits
In this case, cost information that has been separated based on changes and behavior of the company production volume can make it easier for the company to determine its short-term profits. So that the company will also get information that can be used to make decisions in the short term.
Variable Costs Examples
Here are the examples of variable costs that the company uses in determining its production costs:
Direct materials
This material is related to the direct production process. Often these materials are referred to as raw materials. The number of products that a company has produced can affect the direct materials.
Commission
Since this cost depends on the amount of production and sales, commissions will be calculated from each successful product sale in a certain amount.
Fulfillment of production equipment
The production of goods by the company requires good production equipment. So that the production process can run well. An example of this production equipment such as electricity for engines and oil for production machines are regulated in the Procurement System.
Labor overtime pay
In this case, the amount of time that the labor spends for working overtime will be counted as a variable cost.
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Fixed Costs Definition
Fixed costs are company costs that are not dependent on the company’s production activities. In other words, fixed costs are costs that will not change despite an increase or decrease in the company’s production. Costs that are classified as fixed costs must always be paid even if the company is not producing any goods or services.
Functions Fixed Costs
Fixed costs have various functions for the company. With fixed costs, the company will quickly determine the total costs and the variable costs. The company will also be able to find out whether they have returned the capital or not. Not only that, but fixed costs will also make it easier for companies to determine profit in a longer period than variable costs.
Fixed Costs Examples
Here are some examples of fixed costs that the company uses in determining its production costs:
Interest expense
To ensure that the company’s production and operational processes run smoothly, the company usually makes interest-bearing loans. In addition to debt payments, the company must pay interest on a monthly basis.
Insurance
Of course, the company will get insurance to face all possible risks to its operations. For that, the company will pay insurance expenses every month.
Utility
In this case, the utility includes electricity bills, phone bills, water bills, and other bills. These costs must be paid even though the company is not producing goods or services.
Rental fee
The company will rent a place as their operational place. But, of course, to rent a place as an operational place requires a cost.
Depreciation expenses
The production equipment will experience value depreciation because its function also experiences depreciation over time. Usually, the production equipment can only last a few years. After that, the production equipment will be renewed by the company.
Fixed Costs and Variable Costs, What’s the Difference?
Although both are important components in calculating the company’s production costs, these two components are different. By definition, fixed costs are costs or expenses that are not dependent on the company’s production activities.
Meanwhile, variable costs are expenses that depend on the company’s production activities. Then if we view the unit cost, the fixed costs will change the unit price. If the units produced increase, the fixed cost per unit would decrease, and vice versa. In comparison, variable cost remains the same in the production per unit.
Why is It Important to Distinguish between Fixed Cost and Variable Cost?
In the complex world of business finance, understanding the distinction between fixed costs and variable costs is crucial for effective financial management. First and foremost, it provides companies with valuable insights into their cost structure, aiding in budgeting, pricing decisions, and overall profitability.
Moreover, the distinction between fixed costs and variable costs plays a pivotal role in pricing decisions. Companies need to set prices that cover these two costs while generating a profit. By understanding the proportion of fixed and variable costs in their cost structure, businesses can set appropriate pricing strategies.
In conclusion, differentiating between these two costs is of utmost importance for companies. This knowledge empowers organizations to optimize their resource allocation, set competitive prices, and achieve long-term financial success. Therefore, it is vital for companies to gain a thorough understanding of their cost structure and effectively manage fixed and variable costs.
Conclusion
As an important component in calculating the company’s production costs, variable and fixed costs will determine production costs and profits earned by the company. Variable and fixed costs are two distinct components, although both are important components in calculating the company’s production costs. The difference between them can be seen through the definition and the unit cost.
HashMicro as the leading ERP Software vendor in Singapore provides solutions to optimize the calculation of the company production costs easily using an Accounting System that is supported by the best features. Besides that, you can also ensure efficient procurement costs using the Procurement System. Click here to get the best offer and free demos!
