Why Does Everything Cost Money

0
30
 Why Does Everything Cost Money

There are two kinds of expenses: fixed and variable. Fixed costs stay the same no matter how much or how little you produce. Variable costs change based on volume. For example, if you drive a car, maintenance is a fixed cost because it doesn’t go up or down depending on how much or how little you drive your car. But gas is a variable cost since it changes based on how much driving you do. The same is true for pretty much any business venture — almost everything has both types of expenses, except some volunteer ventures like helping to clean up a park or community garden (though even those might require non-expendable supplies). This article discusses why Everything Costs Money and what you can do to change it.

Why Does Everything Cost Money?

Well, even the air we breathe, the water we drink, and almost everything we use cost money. And the only way to get money is to work and get paid for it. And that’s why almost everything costs money. Because without our effort, we can’t get any money.

Fixed Costs.

  • Goods and services are usually fixed costs because they don’t depend on how much or how little of them you produce.
  • Labor is a wrong example because the hours you put in each week do depend on how many hours you work. If I work 40 hours a week and produce $1,000 worth of goods per week, then that $1,000 does not remain constant — it rises when I take on more labor or falls when I take on less. Contrast this with the land where the amount doesn’t change at all even if there’s no building on it but only grass growing in it.
  • Overhead (rent, insurance, etc.) is another unchangeable overhead cost because they don’t go up or down depending on your production level — they remain constant regardless of whether your business grows or shrinks.
  • The same is also true for advertising and other operating expenses that don’t vary as a result of production levels so they too are changes that can not be controlled by Volume Pricing (which assumes all variables remain constant).
  • This is true for marketing as well since very few companies can manufacture their name brands at prices below those of the competition (as most businesses will attest). This is exactly why most businesses pay for advertising and other marketing costs which are proportional to sales volume, not profits! They cannot make money by increasing sales volume alone — they need to reduce their costs input from overheads to survive! 
  • The fixed cost of producing a product doesn’t change regardless of how much you produce — it’s a fixed amount regardless of how much you sell.
  • This is true for the Price-Cost Margin as well since you can’t get a higher margin on low-volume production because the price per unit must be set at some level to cover fixed costs and then the price per unit still must cover your desired price level.
  • This is also why a supplier who wants to increase their sales or profits from some extra production will not take on more employees, add more machines or equipment, build extra inventory, etc — that would just increase the fixed costs of their business so instead they will either have to raise prices (to cover their higher costs) or lower sales volume (to reduce variable costs). Thus when your managers and owners make recommendations for adding new products, lines, locations, etc that ‘should’ decrease variable cost then that is not just wishful thinking but what I call Reality-Based Decision Making! A lot of businesses have purchased unnecessary new machines which was an unnecessary waste of money!

Variable Costs

  1. Variable costs are costs that change as a result of production levels and include the cost of labor, materials, energy, utilities, and other costs that go up or down depending on how much you produce.
  2. Variable costs are not fixed (unlike overhead or fixed) so they can be decreased by raising sales volume (or at least removing unprofitable sales from your books).
  3. The variable cost to make one unit of product A is equal to the total variable cost for producing one unit of product A divided by the quantity produced. For instance, if your variable cost for making 1 unit of product A is $10 then your variable cost for making 1 unit of product B is also $10 but it doesn’t mean that your variable cost for making 1 unit of product B is the same as it was when you only made 1 unit of product A — it means that because you made more units then your variable costs have gone down. This is one reason why many businesses don’t want to produce more than they can sell! They would rather produce less and make more money than produce more and lose money! This is Reality-Based Decision Making!
  4. Some business owners will use a percentage instead of a dollar amount like 50% which means that if their variable cost per unit was $10 then their total variable costs would be $20 (1/2 times as much) while their labor cost per unit would be only $5 ($10 divided by 2 = $5). This is a very common practice and can be justified in many cases.
  5. Variable costs are often called the “front-end” or “production” costs of your business. The fixed cost is the “back-end” or “administration” costs of your business.
  6. The total cost of producing 1 unit of product A is equal to the variable cost for producing 1 unit of product A plus the fixed cost for producing 1 unit of product A. This total cost is known as the Total Product Cost (TPC) at any given point in time. Using our example from above, if you were making only 1 unit of product A then you would have a variable cost per unit of $10 and a fixed cost per unit of $10 and your total TPC would be $20 ($10 + $10). But if you were making 2 units then your total TPC would be $40 ($20 times 2 = $40). If you were making 3 units then your total TPC would be $60 ($20 times 3 = 60). And so on!
  7. Variable costs are what make it possible for businesses to produce more at lower production levels than they could if their variable costs were higher! In other words, variable costs allow businesses to make more profit with less production than they could make with higher production levels! So even though variable costs are only part of Total Costs, they are really what makes it possible for businesses to make money at all!

Why Everything Costs Money

  • The total cost of producing 1 unit of product A is equal to the variable cost for producing 1 unit of product A plus the fixed cost for producing 1 unit of product A. This total cost is known as the Total Product Cost (TPC) at any given point in time.
  • The total amount spent on making goods and services over some time is known as a Total Cost or Total Product Cost (TPC). This includes both variable and fixed costs.
  • The total amount spent on goods and services over some period divided by the number of units produced is called a Marginal Cost or Marginal Product Cost (MPC). This includes both variable and fixed costs.
  • If you are only making 1 unit then your TPC would be $20 ($10 + $10) and your MPC would be $20/1 = $20/unit which means that it takes 20 units to make one unit! If you were only making two units then your TPC would be $40 ($20 times 2 = $40), your MPC would be 20/2 = 10, and it takes 10 units to make one unit! And so on!
  • If a business is producing more goods and services at the same level of cost then it is making more profit than if it was producing a smaller quantity of goods and services at the same level of cost.
  • The total cost of producing 1 unit of product A is equal to the variable cost for producing 1 unit of product A plus the fixed cost for producing 1 unit of product A. This total cost is known as the Total Product Cost (TPC) at any given point in time.
  • Variable costs are what make it possible for businesses to produce more at lower production levels than they could if their variable costs were higher! In other words, variable costs allow businesses to make more profit with less production than they could make with higher production levels! So even though variable costs are only part of Total Costs, they are really what makes it possible for businesses to make money at all!

Variable Costs Can Be Changed To Fixed Costs.

  1. If a business can keep the same level of production each year then it can save money on variable costs by using its fixed costs to reduce the quantity of output per unit.
  2. If a business can keep the same level of production each year then it will save money on variable costs by using its fixed costs to reduce the unit cost per unit.
  3. The Total Product Cost (TPC) of making a good or service is dependent upon both variable and fixed costs. The total cost is not always proportional to the number of units produced because different levels of profit are possible under different levels of output!
  4. Variable Costs Can Be Changed to Fixed Costs. If a business can only make x units each year then it must maintain the same level of variable cost per unit each year for it to maintain its current level of profit! However, if this was not true what changes would need to be made for a given quantity output? A simple way of looking at this is to think back to our production diagram with the two goods, A and B. It’s easy to see that if we raise the level of production of Good A from 20 units to 30 then we have lowered both the variable cost per unit (a) and fixed cost per unit (b). But what happens to the Total Product Cost?
  5. Variable Costs Can Be Changed to Fixed Costs. If a business can make x units each year then it must maintain the same level of variable cost per unit each year for it to maintain its current level of profit!
  6. Fixed Costs Can Be Changed to Variable Costs. If a business can always produce 100 units of product A then it would be wasting money if it used some percentage of its fixed costs for it to lower its total costs for producing

Conclusion

If you have too many expenses, you have a choice: you can either get more customers or get less of something. The less important thing is the thing that you can do without. For example, if you have to hire more employees but don’t have enough customers to pay their salaries, you can get less of something — less office space, less advertising, less inventory, less machinery, less maintenance, etc. Whichever thing you decide to get less of, make sure that you don’t get less of something essential for your customers. If you don’t have enough customers, you are going out of business — customers are essential. Once you have less of something that isn’t essential for customers, you have room to get more customers and stay in business.