While these are the four most common categories for grouping costs, there are other types as well, such as semivariable. In addition, some costs fall into multiple categories, or they may fall into different categories depending on an individual company, the industry it’s in and how it operates.
Fixed costs don’t change based on a company’s level of production. These costs include items like rent, mortgage payments and salaries for administrative personnel. Fixed costs are significant, because they don’t stop if managers temporarily halt production. Some fixed costs don’t stop even if a business folds.
A company’s variable costs are those that change based on the company’s level of activity. For manufacturing companies, for example, each additional unit of production requires purchasing more raw materials.
Variable costs are significant for a company because they are marginal – each additional unit of production adds more cost to the company. These costs can often be lowered through bulk discounts or other breakpoints.
Operating costs include the expenses involved with running a facility (marketing and utilities are prime examples); it doesn’t include costs that are directly tied to production.
Operating costs can be fixed or variable, but they’re generally costs that companies need to pay to stay in business – even if they aren’t producing anything.
Direct costs are those that a company can tie directly to the production or distribution of a particular product. For example, if you run a manufacturing company, direct costs include the labor hours for manufacturing a product, along with costs for running equipment to manufacture that product.
Direct cost is significant because it is the easiest of the four types to allocate to specific activities or product lines, though it’s not usually the easiest place to find cost savings.