How to Categorize Expenses

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Fixed and variable costs

Plot the Fixed Costs curve and the Variable Costs Curve on a graph with Money on the vertical axis and Units on the horizontal axis. You'll notice that the Fixed Cost remains the same and is represented by a straight horizontal line. Vertical Cost, however, forms an upward-sloping concave curve. This is because Variable Costs grow as the business expands and produce more Units.

In preparing budgets you need to differentiate between fixed costs and variable costs.

Fixed costs are those that remain fairly constant within a wide range of production or sales volumes. Examples of fixed costs include:

  • Rent
  • Basic utilities including electric and telephone service
  • Equipment leases
  • Depreciation
  • Interest payments
  • Administrative costs
  • Marketing and advertising
  • Indirect labor, such as salaried supervisory employees

Variable costs are those that change in direct proportion to changes in activity. Examples of variable costs include:

  • Raw materials
  • Direct labor
  • Packaging
  • Depreciation due to usage
  • Power and gas used in manufacturing
  • Shipping
  • Sales commissions
  • Income taxes

Estimates of variable costs that will be incurred during the budget period will depend on the production forecast. On the surface some costs may appear fixed. In reality, however, they represent long-term variable costs. For example, if production or sales volumes increase by a sufficiently large amount, a company may need to lease additional equipment, rent more warehouse space, or hire additional administrative help. Being aware of such constraints will enable you to anticipate the need for expanded capacity and to include these expenditures in your budget requests.

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