Entrepreneurship and Small Business (ESB) Certification Practice Exam

What category do ingredient costs fall under in a business?

1. Fixed cost

2. Variable cost

3. Overhead cost

4. Long-term debt

The correct answer is: Variable cost

Ingredient costs are classified as variable costs because they fluctuate based on the level of production or sales. In a business, variable costs change in direct proportion to the amount of product that is sold or created. For instance, if a bakery produces more cakes, it will need to purchase more ingredients, such as flour and sugar. Therefore, as the production increases, the ingredient costs rise accordingly. Variable costs contrast with fixed costs, which remain constant regardless of the level of output, such as rent or salaries of permanent staff. Overhead costs encompass both fixed and variable elements, as they include indirect costs associated with running a business, but not all overhead is variable. Long-term debt refers to funds borrowed for a period longer than one year, typically used to finance major projects or acquisitions, rather than ongoing operational expenses like ingredient costs. Hence, categorizing ingredient costs as variable costs accurately reflects their direct relationship with production levels.