Published on : 12 November 20213 min reading time
The different types of expense
On the one hand, there are the fixed costs, also known as structural costs. These costs show all your expenses, but do not vary according to the volume of activity. Nevertheless, they remain stable, regardless of billing and production.
On the other hand, there are the variable costs, also known as operating costs. These are the costs that vary according to the volume of your business. Therefore, if turnover or production increase, so do these costs as well.
Generally, fixed costs are rent, insurance and subscriptions, as well as the fees of experts who work in your business on a regular basis. For variable costs, these are mainly raw materials that vary according to the season or the quantity you use, including packaging costs, electricity and the cost of transport of goods and many other needs during production… as in an ASC 842 method.
The break-even point
This is the maximum level of business activity where it does not represent a deficit. It is translated in business language as turnover. It can be expressed in terms of volume of activity or number of days. How to calculate this activity threshold?
It highlights the importance of the classification of variable and fixed costs, so it takes into account their distinction. Usually, the break-even point is equal to the fixed costs over the mark-up on variable costs. And the margin rate is the percentage of turnover without variable costs subtracted with turnover with variable costs. This is the management report that every manager must know in order to properly conduct his business.
Direct and indirect costs
It is important to recognise that you should not mix fixed and variable costs, nor direct and indirect costs.
If you can incorporate costs directly into your costing then they are direct costs. For example, raw materials and packaging of your products.
If you can’t incorporate them into the cost price, then they are indirect costs that you still have to periodically calculate, such as electricity, rent and depreciation according to a distribution method that the company will predefine.
However, you must be careful with mixed costs that combine both variable and fixed costs. For example, a salesperson’s salary, because in addition to his or her salary, he or she may receive bonuses from commissions if he or she increases sales. Expenses are also called mixed expenses for the simple reason that you cannot really classify them, as they can change over time, being fixed and sometimes not.