Companies need to know how costs behave as activity changes.

That activity may be producing more units, or it may be using more employees on a project. It is expected that costs increase as output increases, but different costs behave differently, and we're going to look here at variable and fixed costs and those in between. Our first one here is gonna look at a fixed cost. On my graph, on the x horizontal axis, we've got output, and on the vertical y axis, we've got our costs. A fixed cost doesn't increase as output goes up. As we work more hours, as we produce more units, the cost just stays fixed. A good example of this would be insurance. Insurance doesn't go up with our activity. A step fix cost is slightly different. A step fix cost is fixed for a certain amount of production, but then it suddenly jumps up. A good example here would be if I was an opener, second or third factory, my second factory suddenly makes my fixed costs go up. Setting up a second production shift or opening a second office would be other good examples. The third one here is variable costs. Variable costs vary with good examples. Here would be staff who are paid by the hour. As we ask them to work more hours, then we have to incur more costs.

Lastly, we have mixed costs. Mixed costs have both a fixed and a variable element. A good example here would be telephone and internet bills. You have a base cost, but then you have a cost that goes up with usage as you use the internet more. Another example could be employees who have paid an annual salary. That would be your starting fixed cost, but then they may be paid some kind of bonus that's linked to their production output or performance level. As their output goes up or their performance level increases, then they're gradually paid more. So that gives us the variable elements. Understanding cost behaviors and how costs change output helps us to budget accurately while a fixed cost isn't going to go up as units increase, all of the others step fixed cost, variable cost, and mixed cost are going to see increases in our budgets as activity increases. Understanding these will thus help us control these costs.