Cost Classifications: Fixed and Variable
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Written by Atila on September 21, 2008 – 6:47 pm
We can define (classify) several types of costs on the basis of their relationship to the amount of services provided, often referred to as activity, utilization, or volume. However, such cost classifications require the specification of a relevant range. In dealing with the future, there is always volume uncertainty— the number of patient days, number of visits, number of enrollees, number of laboratory tests, and so on. However, managers often have some idea of the potential range of volume over some future time period.
For example, the manager of Northside Clinic, a small walk-in clinic, might estimate that the number of visits next year could range from 12,000 to 14,000 or from about 34 to 40 per day. If there is little likelihood that utilization will fall outside of these bounds, then the range of 12,000 to 14,000 annual visits defines the clinic’s relevant range. Note that the relevant range pertains to a particular time period—in this case, next year. For other time periods, the relevant range might differ from its estimate for the coming year.
Fixed Costs
Some costs, called fixed costs, are more or less known with certainty, regardless of the level of volume within the relevant range. For example, the clinic has a labor force of well-trained permanent employees that would be increased or decreased only under unusual circumstances. Thus, as long as volume falls within the relevant range, labor costs at Northside Clinic are fixed for the coming year regardless of the number of patient visits.
Other examples of fixed costs include expenditures on facilities, diagnostic equipment, information systems, and the like. After an organization has acquired these assets, they typically are locked into them for some period of time, regardless of volume. Of course, no costs are fixed over the long run. At some point of increasing volume, healthcare businesses must incur additional fixed costs for new property and equipment, additional staffing, and so on. Likewise, if volume shrinks enough, an organization likely would reduce fixed costs by shedding part of its fixed assets and labor base.
