Cost analysis frameworks and applications

Cost Analysis: Categorical Descriptions and a Case Analysis

Variable Manufacturing Costs:

Costs associated with manufacturing that vary depending on the amount of output, such as raw materials and human resources, fall into this category. As these costs change based on production numbers, they are an essential part of an incremental cost analysis.

Fixed Manufacturing Costs:

Those costs associated with manufacturing that remain static regardless of the level of output belong to this category. Overhead, including some amount of energy consumption, leases, property taxes, and inspection fees are all fixed. As such, they have no need to be included in an incremental cost analysis.

Semi-Variable Manufacturing Costs:

Though a base amount of energy is needed to produce a single unit and probably won't vary much to produce 100, it will likely take more energy to make 10,000 units. This is an example of a semi-variable cost; a careful analysis of these costs is essential in an incremental analysis.

Total Production Costs:

The sum of the above costs equal the total manufacturing or production costs. The optimum total cost is that which maximizes profits, and has no bearing on an incremental analysis.

Direct Costs:

Direct costs are those which can be attributed to a specific material, good, or service produced by a firm. The specific amount of labor necessary to produce a single unit of product, for example, would be a direct cost. As these costs directly relate to the product, they are important in an incremental analysis.

Indirect Costs:

Indirect costs are those that cannot be attributed directly and specifically to a product. Building maintenance and administrative costs are two examples; these costs are non-incremental.

Case Analysis: Laundry Detergent

An examination of the production for laundry detergent provides a clear example of the different costs associated with the manufacturing process. The raw materials needed as ingredients for detergents require extraction from natural resources, and extraction costs increase as the amounts needed rise. This means that it costs more to use more materials and thus produce more detergent, making materials a variable cost. The factory where the ingredients are mixed into detergent, however, would cost roughly the same to build whether the plan was to produce 100 or 10,000 units per day -- as this cost does not increase as production increases, it is a fixed manufacturing cost. Energy is semi-variable, in that it would require a significant amount of energy for the factory to operate at all, even if it was only producing one box of detergent a day. At the same time, the factory would certainly use less energy producing 100 boxes than it would producing 10,000.