Cost Descriptors

Cost Descriptors

Introduction

Understanding a company’s budget and finance posture is no easy task. For a new manager or a manager that has not dealt with the finance aspect of a business, comprehending the planning process can be especially tricky. When creating a budget, there are several costs that need to be considered. The following costs are the most important parts of the budget process: fixed, variable, direct, indirect, and sunk.

Fixed Costs

The first cost to examine is a fixed cost. A fixed cost is a cost that remains constant, regardless of any change in a company's activity. A good example of a fixed cost is a lease payment. If you are leasing a building at $2,000 per month, then you will pay that amount each month, no matter how well or how poorly the business is doing (Investopedia, 2008).

Variable Costs

The second cost to look at is a variable cost. A variable cost is a cost that changes in relation to a change in a company's activity or business. A good example of a variable cost is the fuel for an airline. This cost changes with the number of flights and how long the trips are (Investopedia, 2008).

Direct Costs

The third cost to consider is a direct cost. A direct cost is a cost that can be directly traced to producing specific goods or services. For example, the cost of meat in a hamburger can be attributed directly to the cost of manufacturing that product. Other costs, such as depreciation or administrative expenses, are more difficult to assign to a specific product, and so are not considered direct costs (Investopedia, 2008).

Indirect Costs

The fourth cost to account for is an indirect cost. An indirect cost is an expense that is difficult to trace directly to a specific costing object. This is also called common cost. Examples of indirect costs are expenses (such as for advertising, computing, maintenance, security, supervision) incurred in joint usage and, therefore, difficult to assign to or identify with a...