How can you explain cost behavior analysis to clients who are not familiar with accounting?

1 What is cost behavior?

Cost behavior refers to the way that a cost responds to changes in the volume or intensity of an activity. For example, some costs are fixed, meaning they do not change regardless of how much or how little activity is performed. Examples of fixed costs are rent, insurance, and depreciation. Other costs are variable, meaning they change in direct proportion to the level of activity. Examples of variable costs are raw materials, direct labor, and commissions. Some costs are mixed, meaning they have both fixed and variable components. Examples of mixed costs are utilities, maintenance, and salaries.

2 Why is cost behavior important?

Cost behavior is important because it affects the profitability and performance of a business. By knowing how their costs behave, managers and business owners can make better decisions about pricing, production, and resource allocation. They can also forecast their revenues and expenses more accurately, and monitor their cost efficiency and effectiveness. Cost behavior analysis can also help them identify potential cost savings and improvement opportunities.

3 How to classify costs by behavior?

To classify costs by behavior, managers and business owners need to analyze the relationship between a cost and an activity. The activity is usually measured by a cost driver, which is a factor that influences or causes a cost to occur. For example, the cost driver for raw materials is the number of units produced, and the cost driver for rent is the number of months. The cost behavior can be determined by observing how the cost changes as the cost driver changes. For example, if the cost increases or decreases by the same amount as the cost driver, then the cost is variable. If the cost does not change at all as the cost driver changes, then the cost is fixed. If the cost changes by a different amount than the cost driver, then the cost is mixed.

4 How to separate mixed costs?

Mixed costs can be tricky to analyze because they have both fixed and variable elements. To separate mixed costs, managers and business owners need to use a method that can isolate the fixed and variable portions of the cost. One common method is the high-low method, which uses the highest and lowest levels of activity and the corresponding costs to calculate the variable cost per unit and the fixed cost. Another common method is the regression method, which uses a statistical technique to fit a line that best represents the relationship between the cost and the activity. The slope of the line is the variable cost per unit, and the intercept of the line is the fixed cost.

5 How to use cost behavior information?

Once managers and business owners have classified and separated their costs by behavior, they can use the information to perform various analyses and calculations. For example, they can use the variable cost per unit and the fixed cost to compute the break-even point, which is the level of activity that results in zero profit or loss. They can also use the cost behavior information to prepare a flexible budget, which is a budget that adjusts to different levels of activity. A flexible budget can help them compare their actual results with their planned results, and identify the causes of any variances. Additionally, they can use the cost behavior information to evaluate the impact of different scenarios and decisions on their profitability and performance.

6 How to communicate cost behavior analysis to clients?

To communicate cost behavior analysis to clients who are not familiar with accounting, managers and business owners need to use simple and clear language, and avoid jargon and technical terms. They also need to provide examples and illustrations that are relevant and meaningful to the clients' business and industry. They should explain the benefits and limitations of cost behavior analysis, and how it can help them achieve their goals and objectives. They should also invite questions and feedback from the clients, and address any doubts or concerns they may have.

7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?