Cost behavior

Cost behavior
See also
Differential costing Differential cost Step cost Step fixed cost Allocated cost Variable Cost Ratio Functional budget Hidden cost Cost risk

Cost behavior is the way in which the costs of the company change due to current events that take place in the company.

The basic principle of cost behavior is their increase during the increasing production activity of the company and decrease in costs during the reduced production activity of the company. But there are exceptions to this rule.

Cost control and knowledge is an important task in the work of every manager or executive. Such knowledge allows for good functioning of the organization or company. By determining the cost behaviour it's very important to know whether the costs will exceed revenues or be lower than revenues in a given market situation. Costs can vary greatly. They can divide into those that are subject to a lot of factors and change very often. There are also those that are very stable and hard to influence by any action. The ability to anticipate events that cause costs to rise is an important ability in the company in the area of financial management.

Among the factors that have a fundamental impact on the behavior of costs, two types of costs can be distinguished in each company. Fixed costs and variable costs where:

• Fixed costs - are those that do not change with the increase or decrease in the production.
• Variable costs - are those that change with the increase or decrease in the production.

Asymmetric cost behavior

In economics, contrary to the standard and well-known principle of cost behaviour, where an increase or decrease in a company activity results in a proportional increase or decrease in costs, there is also a concept more commonly known as asymmetric cost behavior. Asymmetric cost behaviour refers to a situation where an increase or decrease in a company's activity results in a disproportionate change in the cost behaviour.

Sticky costs

Enterprise costs can be called "sticky costs" when they grow faster when the company's activity increases than when the company's activity decreases while maintaining the same amount in both cases. Companies whose costs are sticky record much greater decreases in revenue than companies whose costs are not sticky. This is because sticky costs lead to much smaller cost adjustments with decreasing production activity, leading to much lower cost savings. Less cost savings lead to lower revenues for the company .

Examples of Cost behavior

• Fixed costs: Fixed costs are costs that remain the same regardless of changes in the level of production or sales. Examples of fixed costs include rent, insurance, and salaries.
• Variable costs: Variable costs are costs that change depending on the level of production or sales. Examples of variable costs include raw materials and cost of goods sold.
• Semi-variable costs: Semi-variable costs are costs that have both a fixed and a variable component. Examples of semi-variable costs include utilities and maintenance costs.
• Step costs: Step costs are costs that increase at a steady rate as production or sales increases. Examples of step costs include marketing expenses and depreciation.

Advantages of Cost behavior

Cost behavior is a useful tool for understanding how changes in production, sales, and other activities can impact the costs of a company. The main advantages of cost behavior include:

• Improved Decision Making: Understanding cost behavior can help a business make more informed decisions about production and sales, as well as other activities. Knowing the cost behavior can help the company identify where it can save money and make more efficient use of resources.
• Reduced Risk: By understanding the cost behavior of a company, the business can get a better idea of how much risk it is taking on and how it can reduce or avoid certain risks. This can help the company become more efficient and profitable.
• Increased Profitability: By understanding and controlling cost behavior, a company can increase its profitability by reducing costs and increasing revenue. This can ultimately lead to increased profits and a stronger bottom line.

Limitations of Cost behavior

Cost behavior is a useful tool for helping companies analyze and track costs, but it has some limitations that should be taken into consideration. These limitations include:

• Cost behavior does not take into account the long-term implications of certain decisions. For example, a company may choose to reduce expenses in the short-term, but that same decision may lead to higher costs in the future as a result of lost opportunities or increased costs to make up for the short-term savings.
• Cost behavior does not always accurately predict future costs. It is possible for unexpected events to significantly affect costs in ways that were not anticipated.
• Cost behavior is based on past data and may not take into account potential changes in the market or the company's operating environment.
• Cost behavior can be difficult to interpret correctly, as it requires a thorough understanding of the various factors that can influence costs.

Other approaches related to Cost behavior

Cost behavior is an important factor for any business to consider in order to remain competitive and profitable. There are a few other approaches related to cost behavior that can help in improving the overall financial performance of a company. These include:

• Cost-Volume-Profit Analysis: This approach helps to identify the relationship between cost, volume, and profit. It can be used to determine the break-even point, analyze the effect of changes in cost and volume on the company's profits, and also to evaluate pricing strategies.
• Activity-Based Costing: This approach looks at the cost of activities rather than products or services. It helps companies to better understand the cost of each activity and identify areas where costs can be reduced.
• Life Cycle Costing: This approach looks at the cost of a product or service over its entire life cycle. It helps businesses to identify costs associated with research and development, production, marketing, and distribution.

In summary, cost behavior is a key factor for any business to consider in order to remain competitive and profitable. Cost-Volume-Profit Analysis, Activity-Based Costing, and Life Cycle Costing are all approaches that can help in improving the overall financial performance of a company.

References

• Anderson M., Banker R., Huang R., Janakirama S., (2006), Cost Behavior and Fundamental Analysis of SG&A Costs, The University of Texas at Dallas, Fox School of Business, Temple University p. 2 - 9
• Banker R., Byzalov D., Chen L. , (2013), "Employment protection legislation, adjustment costs and cross-country differences in cost behavior", Journal of Accounting and Economics, Elsevier, p. 2-14
• Baumgarten D., (2012), The Cost Stickiness Phenomen, Springer Gabler, p. 93 - 96
• Finker S., Jones Ch., Kovner Ch., ( 2013 ), Financial Management, Elsevier, p. 132 - 134
• Reimer K., (2017), Asymmetric Cost Behavior, Springer Gabler, p. 2
• Weiss D., ( 2010 ), " Cost Behavior and Analysts, Earnings Forecasts", The Accounting Review, p. 1440 - 1450

Author: Maciej Plęskowski