Cost Descriptor

Cost Descriptors

Being able to plan for a business successfully depends heavily on the financial manager who has a comprehensive knowledge of many inter-related financial factors. Various financial factors can have direct and indirect affects on the operating costs of the business. Some of these factors could be influenced by the financial condition of the company, and others could be the on-going changes brought about by the macro-economic prospects. Before making any future investment plan, it is very important that a financial manager thoroughly understands the existing budgeting condition of the company. Then the magnitude of investment can be estimated based on the existing situation of economic atmosphere. For example, in a recessionary period, consumers are less likely to spend. Companies with large capital investment during this period are likely to have excessive inventory build-ups and not able to achieve a desirable return of investment. Unemployment during the recessionary period will tend to be high, and companies may be expected to exercise layoffs in order to cut operating and to remain in business. The purpose of this paper is to expand on the topics regarding costs. The type of costs to be discussed is fixed cost, variable costs, direct costs, indirect costs, sunk costs, period costs, and product cost.

Fixed costs are the operating expenses that do not fluctuate in proportion to the business activities. This type of operating expense is independent of the goods a company produces or sells. According to Block (2004), some time the fixed costs still incurred even when the business is not producing any goods at all. For instance, the human resource department may decide to cut-back on hiring employees. On the other hand, it chooses to allocate budget for the purchase of more sophisticated equipments. For the long run, a reduction in labor cost and a continuous increase in production volume would be a cost saving factor, because it gives the company a higher operating leverage. However, if company faces economic slow down before it reaches the profit break even point, it will have to incur the fixed cost of the equipments.

Variable costs, on the other hand, are the operating expenses that can be easily adjusted to match uncertain results of the fluctuating business activities, block (2004). The use of variable costs planning allows business to increase or decrease its budgeting depending on the volume of sell that it could achieve in the short future. In contrast to the use of high level of fixed assets as a mean of achieving optimum long-term operating leverage, this method is more conservative. It is the most desirable mean in situations which the business is new, and economic future is unstable, as described in Block (2004). Most often, the fear of not able to reach the break even level in revenue is the primary reason that companies decide to increase the variable costs assets instead of fixed cost assets. As for the human resource example mentioned earlier, it would be required to hire more employees when productivity is high. Then when productivity is low, it can reduce its work-force and not having to be locked into the financing of the fixed equipment costs.

Costs can be break down into either direct cost or indirect cost. Direct costs are expenses that can be identified specifically with the manufacturing cost of a product. Indirect costs, on the other hand, are not directly accountable for the cost of the product. Direct costs can be associated to either variable costs or fixed cost depends on situations. Indirect cost similarly can be associated to either variable or fixed costs. For example, some employee salaries are