Definition
During the normal operation cycle, there are several costs that businesses normally incur. Classification of these costs tends to be important because it helps organizations make important decisions regarding pricing and product strategy.
Costs within an organization are mainly divided into fixed and variable costs.
As far as fixed costs are concerned, it cannot be seen that they do not change with the level of output at which the company is operating.
On the other hand, variable costs change with output and are directly correlated with the level of operation in the company.
However, in addition to this black-and-white classification of costs, there is also a third type, which is referred to as mixed costs.
Mixed Costs can simply be defined as costs that include both fixed and variable components. Therefore, they can best be described as costs that have a fixed component and a variable component.
As far as the fixed component is concerned, that does not vary with the output level.
The company is meant to incur that particular regardless of its output level. On the other hand, the variable component of the mixed cost will directly vary following the level of output (or level of usage) within the company.
Hence, mixed costs can be defined as costs incurred by the company, which cannot strictly be classified as either fixed or variable.
Instead, they comprise both, fixed and variable components. Both these components are added together to arrive at the total mixed cost of the company.
The Formula of Mixed Cost
To calculate a specific cost that is classified as a mixed cost, the following formula can be used:
Mixed Cost = Fixed Cost + (Variable Cost Per Unit x Level of Output)
The formula above shows that the mixed cost has both components, which need to be added together to arrive at the total figure of the mixed costs.
Example of Mixed Costs
Mixed Costs can further be explained using the illustration given below:
Jain Co. is a manufacturing concern, and they have outsourced their manufacturing for the production of T-Shirts to Tee Co. They have mutually agreed upon a fixed cost per month of $5,000, and an additional charge of $10 per T-shirt produced. For the month ended 31st December 2020, Jain Co. ordered 750 T-shirts from Tee Co. What was the total cost incurred?
In the example given above, it can be seen that the manufacturing costs of Jain Co. can best be described as mixed costs.
This is because they have agreed upon a fixed monthly payment of $5,000, in addition to a variable charge for t-shirts, depending on the overall output that is produced.
Hence, in this case, the calculation of mixed costs can be done in the following manner:
Mixed Costs = Fixed Costs + (Variable Cost Per Unit x Level of Output)
Mixed Costs = 5000 + (10*750) = 5000 + 7500 = $12,500
Therefore, it can be seen that the total Mixed Costs for Jain Co. amount to $12,500.
Other than the example above, during the normal course of business, there are numerous examples of mixed costs that the company bears and pays.
For example, telephone and electric subscriptions are often classified as Mixed Costs.
This is because they comprise the fixed component (the line rent, or the flat monthly subscription charge), and then a variable component directly related to the amount of electricity they have used over time.
What Are the Importance of Mixed Costs?
The importance of mixed costs lies in their ability to enhance various aspects of business operations. Here are some key areas where mixed costs play a crucial role:
Budgeting: Mixed costs contribute to creating more accurate budgets. By comprehending a mixed cost’s fixed and variable components, managers can better forecast cost fluctuations as activity levels change.
This understanding helps ensure that budgets are realistic and costs are considered and measured.
Decision-making: Mixed costs aid in making informed decisions. For instance, when a company considers expanding its production, it can employ mixed costs to estimate the additional costs that will be incurred.
This information enables the company to make a well-informed decision about whether to proceed with the expansion.
Cost control: Mixed costs facilitate improved cost control.
By understanding the fixed and variable elements of a mixed cost, managers can identify areas where costs can be reduced.
For example, if the variable component of a mixed cost is high, managers may negotiate lower prices with suppliers, thereby reducing overall costs.
Pricing: Mixed costs play a significant role in setting prices. Managers can determine appropriate pricing for their products or services by understanding a mixed cost’s fixed and variable components.
This understanding ensures that prices are set at a level that covers costs and generates a profit, contributing to the financial stability and sustainability of the business.
What Are the Limitations of Mixed Costs?
The utilization of mixed costs in business analysis is not without its limitations. Here are some key limitations to consider:
Difficulty in identifying individual cost components: One limitation of mixed costs is the challenge in accurately identifying the individual components of a mixed cost.
It can be arduous to distinguish between the fixed and variable elements, as they often overlap and are not easily separable.
Accuracy of separation: The accuracy of separating a mixed cost into its fixed and variable elements depends on the method used.
While some methods may provide more accurate results than others, all methods inherently possess a certain degree of error. This introduces potential inaccuracies and uncertainties in the analysis.
Changes in cost behavior: Another limitation arises from the fact that the cost behavior of a mixed cost can change over time.
This is due to fluctuations in the fixed and variable components. For instance, the fixed component of a mixed cost may increase over time due to factors like inflation, thereby altering the overall cost behavior and complicating accurate predictions.
Complexity: Analyzing mixed costs can be complex and demanding. It involves employing statistical methods to separate the fixed and variable components effectively.
These methods often require specialized expertise and can be time-consuming, adding complexity to the analysis process.
What is the difference between mixed costs and semi-variable costs?
The main differences between mixed costs and semi-variable costs can be summarized as follows:
Definition:
- Mixed Cost: A mixed cost refers to a cost that consists of both fixed and variable components.
- Semi-variable Cost: A semi-variable cost also contains fixed and variable components, but the variable component changes in steps rather than smoothly.
Behavior:
- Mixed Cost: The fixed component remains constant in a mixed cost, while the variable component changes proportionally with the activity level. In other words, as the activity level increases, the variable cost component increases as well, but in a linear manner.
- Semi-variable Cost: In a semi-variable cost, the fixed component remains constant, but the variable component changes in steps or increments as the activity level increases. This means that the variable cost component remains constant within a specific range of activity levels, then jumps to higher when the activity surpasses a certain threshold.
Examples:
- Mixed Cost: Examples of mixed costs include rent, depreciation, and insurance. These costs have a fixed portion that remains constant and a variable portion that changes with the activity level.
- Semi-variable Cost: Examples of semi-variable costs include utilities like electricity, security services, and janitorial services. These costs have a fixed portion that remains the same regardless of the activity level and a variable portion that increases in steps as the activity level surpasses certain thresholds.
Separation:
- Mixed Cost: A mixed cost’s fixed and variable components can be separated using statistical methods, such as analyzing historical data and employing techniques like regression analysis.
- Semi-variable Cost: A semi-variable cost’s fixed and variable components can be separated using linear regression analysis, which helps identify the fixed cost portion and the step-wise variable cost portion.