Semi-variable costs

What it means

Semi-variable costs have a fixed element paid regardless of output or sales and a variable element that grows with volume. Typical examples are a phone plan with charges for extra minutes, energy with a standing connection charge plus consumption, or pay with a base salary and a performance element.

They sit between pure fixed costs, such as rent, and pure variable costs, such as the material in a product. Real companies have many such costs, so splitting them correctly matters for planning, costing and pricing decisions.

Some costs are fixed only up to a certain capacity and then jump, for example when another warehouse must be rented or another person hired. These step costs are sometimes classed as semi-variable too, because they change with volume, though not smoothly.

How it works in practice

For costing purposes semi-variable costs are split into fixed and variable parts. Common methods are the high-low method, which compares costs at the highest and lowest volumes, and regression analysis on monthly data over a longer period.

A correct split is a precondition for calculating the break-even point. If a company treats all electricity as fixed, it understates variable cost per unit and arrives at a break-even point lower than the real one; in pricing decisions that can lead to selling at a loss.

When negotiating with suppliers it pays to watch the balance between fixed and variable elements. A higher flat fee with a lower unit price suits consistently high volume, while a lower fee with a higher unit price protects the company in a downturn, when fixed commitments are hard to cut.

What to watch out for

A split based on past data holds only within the range of volumes the company has operated in so far. Strong growth or decline can reveal jumps that historical data do not show, so plans should also be checked with common sense.

Financial accounting does not divide costs into fixed and variable; the profit and loss statement shows them by nature. The split is a task for management accounting and controlling, and it must be updated regularly to avoid distorted costings.