This article throws light upon the top seven advantages of classifying cost into fixed and variable cost. The advantages are: 1. Profit Planning 2. Effective Cost Control 3. Fixation of Selling Prices 4. Marginal Costing and Break-Even Analysis 5. Budgetary Control 6. Proper Absorption of Overheads 7. Helpful in Decision-Making.
The Primary objective of doing any business is to earn profits. Hence, it is very important to make profit planning. Profit planning is concerned with taking a series of decisions and selecting amongst the various alternatives available. Thus, it is very important to study the behaviour of costs and profits in relation to change in the volume of output.
Effective Cost Control:
Profits can also be increased through effective cost control and cost reduction. Classification of costs into fixed and variable elements helps management to control costs effectively as fixed costs are incurred by management decisions and can be controlled only by the top management. Further, variable costs may be controlled even at the lower levels of management.
Fixation of Selling Prices:
Profits could be maximised either by reduction and control over costs or by increasing the sales value through increase in sales volume or prices. Fixation of proper selling prices is thus very important for the management.
The segregation of costs into fixed and variable elements enables the management to adopt the most appropriate selling price policy as sometimes one may have to sell even below total cost. However, the selling prices should not be below the variable cost.
Marginal Costing and Break-Even Analysis:
The basic assumption of marginal costing, breakeven analysis and cost-volume profit analysis is that all elements of cost can be segregated into fixed and variable. Hence, for the use of marginal costing and break-even techniques, the classification of costs as fixed and variable is very essential.
For the preparation of flexible budgets and effective budgetary control, this classification is a pre-requisite. The flexible budget is designed to change in accordance with the level of activity and hence the cost behaviour is very important.
Proper Absorption of Overheads:
The analytical study of the behaviour of costs also helps in the proper absorption of overheads as the method to be adopted for the absorption depends upon the nature of overhead.
Helpful in Decision-Making:
The classifications of cost into fixed and variable elements helps management in taking many decisions such as make or buy decisions, selection of a proper product mix, capacity decision, operate or close down decisions, etc. Thus, this classification is very essential for not only ascertainment of cost but also for profit planning, cost control and decision-making.