Examining the components of the total cost of production is an important activity for any business owner or manager. Total cost for any enterprise has two components -- fixed and variable costs. You as a manager can control variable costs but not fixed costs. Knowing and understanding the cost structure of your business will help you contain costs and increase your profit margin.
The Components of Total Cost
Fixed costs do not change regardless of how much you produce -- you pay them even if your business produces nothing. The most obvious fixed cost is your rent payment. Other fixed costs might include administrative overhead, interest on debt, depreciation, insurance and lease payments on equipment. Variable costs change as your level of production increases. Variable costs include the cost of energy, labor employed in production, transportation, supplies and raw materials to manufacture your products. Once you know how your total cost changes as you increase your output, you can calculate your average total cost -- total cost divided by output -- to determine your optimal level of efficiency where average total cost is the lowest.
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