Understanding Types of Costs for Planning

Posted 30/08/2019

Costs, or expenses, are a necessity to a business’ development. Expenses must be wholly and exclusively for business purposes for them to be fully deductible against business income for tax relief purposes. For most businesses, the basics of what a cost entails is sufficient information. Managers and planners in large organisations, however, are the ones who would want to know the types of expenses and categories of decisions they face for projects. Knowing what costs fall under which category can help decision-makers review alternative courses of action and make decisions that benefit the company.

Decisions play a large part in the day-to-day planning operations of a business and are vital to any choice that the company makes, ranging from employees and business environments to the costs and units of goods and services sold. Avoidable and unavoidable costs, also known as relevant and irrelevant costs, are two main categories that future expenses can fall in to. Unavoidable costs are expenses that cannot be saved, such as the rent on business properties, and must therefore be paid. Unavoidable costs are irrelevant to decision-making because they will be payable no matter what choice is made. Avoidable costs are relevant to decision-making and can be affected by the different courses of action available. This makes them one of the areas of focus when a decision is being made as the outcome will impact the budget of the company.

Sunk costs are costs that will be unaffected by future decisions and are thus irrelevant for decision making. These differ from unavoidable costs as sunk costs have already been incurred by the business and have already been paid for money which cannot be recovered. Focusing on these irreversible costs during a decision-making exercise detracts attention from the relevant costs.

Opportunity costs must certainly be reviewed during the decision-making process. When a certain choice of action is selected other opportunities arising from alternative action will be lost, and it is these that are the opportunity costs. This usually applies to scarce resources. A resource can be classed as scarce when a limit is involved. This can range from a limited number of the resource being available, or that the resource is being sold on a timer such as a seasonal sale or a limited time offer with a benefit like free shipping. If the resource in question will still be available after the decision has been made in the same situation then it will not be scarce, and the cost will not be considered a sacrifice for the decision.

Incremental costs is the total production costs of the goods or services to be made within a decision which makes them relevant costs to be examined. The costs can be either fixed or variable costs; so long as they contribute to an increase in additional or new product production they will fall under this. Incremental costs are not to be confused with marginal costs, which examine the additional cost of one unit rather than the output as a whole.

Tags: expenses, running a business, business set up, running costs