State the importance of differentiating between the fixed costs and variable costs in managerial decision?

Fixed Costs: These are those costs which remain fixed up to certain range of work capacity no matter how much product you produce within that capacity range. Like factory building rent. You pay the rent no matter that did you use that building for making the products or not. 

Variable Costs: These are those costs which change with the change in the number of product units you produce. Like Material , Labor etc 

Mixed Cost/Semi Variable Costs: These are those cost the part of which is remain fixed and some part of the cost is variable. 

Fixed vs. variable costs
Understanding the process of managing costs first requires an understanding of two general types of costs: fixed and variable.

Fixed costs, or sunk costs as they are sometimes called, are those that generally do not vary between payment intervals. Generally, these costs cannot be altered on a short-term basis because of contractual agreements or simply because it is impractical. 

Table 1: Examples of fixed and variable costs 

Fixed monthly costs  

Rent.............................................................................. $1,100 

Yellow pages ad............................................................ $400

 Loan payment................................................................ $500

 Office manager’s salary.................................................. $3,000

 Doctor’s salary.............................................................. $5,000 

Total fixed costs............................................................ $10,000 

Variable costs per patient visit Supplies (forms, covers, etc.)......................................... $3 

Electricity to operate a roller table.................................. $1 

Collections costs (stamps, invoices, etc.)........................ $1

The way to determine your fixed costs is to consider the expenses you would continue to incur if you temporarily closed your practice and no patients were being treated. In this case, your rent, car leases, yellow page ad fees and loan payments would still be due. They generally do not change with increases or decreases in business activity.

It is important to note that fixed costs are unvarying only within a certain range of business activity. For example: if the practice grows enough to require additional space or additional employees, the fixed costs associated with rent or salaries will change as well.

Variable costs are those that change as the level of business activity changes. Examples of the variable costs within a chiropractic business would be supplies used for each patient visit, collection fees paid to external billing agencies and wages for hourly, part-time employees. These costs are driven primarily by the practice’s business activity, by number of patients that the practice treats.

The “closed practice” test we used above to determine the fixed costs of a practice can also be used to determine the variable costs. The variable costs are those that would stop if the practice were closed for a month and no patients were treated at all.

Once you understand the difference between fixed and variable costs, it is important to know how to distinguish one from the other. For instance, consider a practice that has fixed costs of $10,000 and variable costs of $5 per patient. (See Table 1 for an example of fixed and variable costs.)
To cover its monthly expenses, the practice would have to earn $10,000 in fees plus $5 per patient treated. If the practice had only one patient visit per month, it would have to charge $10,005 for that one treatment in order to cover its fixed and variable costs!

If the practice had 1,000 patient visits during the month, its total costs would be $15,000 ($10,000 in fixed costs plus 1,000 patient visits at $5 each). Therefore, this practice would only have to charge $15 per patient visit to cover its fixed and variable costs.