What is a Step Cost?

Step costs are costs that will remain fixed over the range of a certain activity and after that they’ll change. Basically, these types of costs change in batches or certain fixed ranges at some point in time. As your capacity and operations change these ranges will change as well changing your cost structure (both fixed and variable expenses).

Step expenses incorporate features associated with both variable and fixed expenses in a manner that step expenses change when manufacturing levels change – once a specific manufacturing quantity of activities is achieved. Inside this range of activity, step expenses will stay fixed. The main difference between step costs and fixed costs is that step costs tend to be changed by activity level and as a result they’ll generally change more often than your fixed costs.

In order to demonstrate how step costs work, let’s use a very simple example of one worker manufacturing 10 product items per shift. When production demand changes from 10 to 45 items per shift the company will have to hire additional 4 workers. When the demand increases from 45 to 50 still the fixed costs will remain the same as the 5 workers can still manufacture 50 items per shift. However once the demand exceeds 50 items the organization will have to hire additional workers. In this simple example of step cost we can easily identify that within the range of 10 items the fixed costs would not change however when demand changes for more than 10 items the fixed costs will increase because more manpower is needed.

Company costs which are consistent for the assigned degree of action, yet raise or lower when a certain limit is crossed are step costs. Step costs are those expenses which change whenever a company’s manufacturing quantities go up or down drastically.

It is the manager’s job to manage and forecast the business demand, operations and costs. The point where a step cost is going to change (fixed cost increases) can be postponed by applying many management and operations concepts and know-how in order to boost productivity and achieve the required manufacturing level by using the current manufacturing capacity and settings.

These same types of costs are present in every type of business organizations and not only in manufacturing or production segments. Another simple example of step cost is a restaurant where 1 waiter is able to serve up to 25 customers per hour in order to keep up with the required service quality and responsiveness. If the number of guests in the restaurant increases from let’s say 20 guests per hour to 30 guests per hour the restaurant will have to hire additional waiter (raise the fixed costs) in order to keep up with the same service quality.

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In other words, step cost is a cost that will not change continuously, but instead it is going to change only at specific points. It is really a fixed cost inside specific limits, beyond which it is going to change.

Related Resources:

Cost Reporting and Management with Excel: Financial Templates

How to Monitor and Organize Your Business Reports with Excel Dashboard

ABC Costing Examples

Financial Ratios: Example Financial KPIs and Metrics

Project Cost Estimate Tips

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