Why is understanding cost behavior important?
Understanding how different types of costs behave provides critical information for a variety of activities that support the budgeting process. Some of these activities are: • Forecasting To forecast future costs, you must understand the breakdown between fixed and variable costs, as well as understand the cost drivers. For example, if unit sales are a driver of variable costs, such as direct materials and direct labor, then those costs can be estimated based on the unit sales forecast and the expected unit costs of materials and labor. • Breakeven analysis Breakeven analysis helps you determine when your business will be able to cover all of its expenses and begin to make a profit. This analysis uses a simple mathematical equation, but you need to understand your fixed costs and variable costs before you solve the equation. • Operating leverage Operating leverage reflects the level of risk in your cost structure. If your company has relatively low levels of fixed costs in your cost st
