Fixed and Variabl Costs

The study of cost behavior in physical distribution is quite similar to that in manufacturing because most of the activities are repetitive in nature. Under such conditions physical measurements such as man-hours, units handled, and orders processed can be used to measure the activity. Changes in the level of cost incurred usually are caused by changes in the level of activity experienced.

The first step in understanding the cost behavior of physical distribution activities is to establish the relationship between the amount of each cost and an appropriate measurement of the level of activity. Variable costs are those costs that change in proportion to changes in volume and fixed costs. Examples of variable costs include the handling charges in a public warehouse and the cost of packing material used in a shipping department. Fixed costs include depreciation, security costs and taxes on company-owned warehouses, and the salary of transportation manager.

Some costs are mixed, that is, they contain both a fixed and a variable component. An example might be a warehouse labor. A basic crew of three may be required to cover the normal range of activity. However, if the volume of activity exceeds a certain amount, overtime or part-time employees may be necessary.

In some cases costs may be fixed over a relevant range but may increase in steps. These costs may be referred to as step variable cost or step fixed costs. The major distinction is the size of the steps. For example, in an order-processing department of twenty people labor may be considered a variable cost without making a serious error. This is because a relatively small percentage change in the number of orders could result in a change in the number of employees. However, in a department of three people the cost should be considered a fixed cost since a large percentage change in the number of orders processed usually would be required in order to eliminate an employee. Other examples of step fixed costs include the costs of management salaries, depreciation, and taxes associated with each warehouse that the company owns and operate.

Effective planning and control require that the total costs be separated into the fixed and variable components.

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