Cost behavior is the manner in which expenses are impacted by changes in business activity. A business manager should be aware of cost behaviors when constructing the annual budget, to anticipate whether any costs will spike or decline. For example, if the usage of a production line is approaching its maximum capacity, the relevant cost behavior would be to expect a large cost increase (to pay for an equipment expansion) if the incremental demand level increases by a small additional amount.
The general types of cost behavior fall into three categories. First is variable costs, which vary directly with changes in business activity. For example, there is a specific direct materials cost associated with each product sold. Second is fixed costs, which do not change in response to business activity levels. For example, the rent on a building will not change, even if the sales level of the tenant changes dramatically. Finally, there are mixed costs, which contain fixed and variable elements. For example, an Internet access fee includes a standard monthly access fee (which is fixed) and a broadband usage fee (which is variable).
Understanding cost behavior is a critical aspect of cost-volume-profit analysis.