The identification of costs is a crucial aspect of any business and is required in order to understand and set products and pricing structures. For those who operate their business from home, a simple and organized way of identifying costs is to visualize one’s daily activities and record each item which is used and requires purchasing.
Business costs may be divided into three main categories:
- Capital costs and revenue costs
- Direct costs and indirect costs
- Fixed costs and variable costs
Understanding Capital Costs and Revenue Costs
Capital costs (often referred to as capital expenditure) are those related to expenses occurring as a result of purchasing either permanent or capital resources in the organization known as fixed assets. This may include money spent to increase the value of any existing fixed assets such as creating an extension to increase the size of the workplace environment. Capital expenditure also involves money spent on legal fees associated with purchasing property as well as both the carriage and installation of work machinery.
In contrast to capital costs, revenue costs are those which are necessary for the day-to-day running of an organization. Unlike capital costs which typically last a long time, revenue costs include those which are used up within the space of a year. Example of revenue expenditure include items purchased for resale, materials used in manufacturing in addition to common expenses such as heating, lighting, rent, rates, and salaries.
Understanding Direct Costs and Indirect Costs
In the majority of financial management related processes, daily costs associated with running a business unit come under the category of direct and indirect costs. The former costs are those which are essential or directly involved in the production of one’s products while the latter refers to expenses related to supporting the product service. A common aspect associated with indirect costs are those required to undertake processes pertaining to administration. Indirect costs are those which are typically referred to within the business environment as ‘overheads.’
Some costs may be both partly direct and partly indirect, such as in a restaurant where the chef’s salary would come under the heading of direct expenses in contrast to the bookkeeper responsible for the preparation of the restaurant accounts which would be identified as an indirect cost.
Understanding Fixed Costs and Variable Costs
The major difference between fixed costs and variable costs is simple to understand as the former are costs which remain constant while the latter relates to costs which vary in proportion to aspects such as sales or production levels. Fixed costs may include those things which are paid at a fixed rate similar to when one is paying a direct debit that is set at the same specific price each month. Examples of fixed costs are areas such as rent, insurance, loan interest, and staff remuneration.
Variable costs may include things like overtime wages, essential stationery, petrol as well as other business costs. These costs may also include advertising and are related to how productive the business is and budgets.
As highlighted above, costs within the business environment may be categorized into three main groups which include fixed and variable costs, those which are direct and indirect as well as capital and revenue expenditure.