3 Determining fixed versus variable costs

The material, labour and machine resources needed to make a unit of a particular product (or provide a unit of a particular service) could be measured and then divided over the units to be produced, to give a unit variable cost. However, in practice things are not always as simple as that as many costs are semi-variable, with both variable and fixed components. Despite this complication, many planning and decision-making activities require an understanding of how costs change as the level of output changes. This requires separating costs into their fixed and variable elements.

There are a number of techniques, of varying degrees of sophistication, available to management for estimating fixed and variable costs, but you should always bear in mind that greater and greater levels of accuracy are usually more expensive to attain. Such levels of accuracy may also take longer to achieve because of the amount of information that has to be processed.

Organisations must always keep in mind that information has a cost and that it is pointless to have more detail and accuracy than necessary. The following subsections describe two techniques that could be applied for the purpose of estimating fixed and variable costs.