Fixed vs Variable Cost

Knowing the difference between expenses and revenue is the key to understanding the profitability of your business. As fixed and variable costs make up the cost structure of your business, understanding the fluctuation of expenses and how they tie into your sales volume can help you make sound business decisions that will ultimately drive profits. 

Fixed costs and variable costs are two main types of costs a business can incur when producing goods and services. Businesses use fixed costs for expenses that remain constant for a specific period, such as rent or loan payments, while variable costs are for expenses that change constantly, such as taxes, labour, and operational expenses.

Fixed costs are generally easier to plan, manage, and budget for than variable costs. However, as a business owner, it is crucial to monitor and understand how both fixed and variable costs impact your business as they determine the price level of your goods and services. 

Fixed costs refer to predetermined expenses that will remain the same for a specific period and are not influenced by how the business is performing. Since most businesses will have certain fixed costs regardless of whether there is any business activity, they are easier to budget for as they stay the same throughout the financial year.

A good way of determining what your fixed costs are is to think about the costs your business would incur if you had to temporarily close. As an example, you would still have to pay rent and insurance, which would be considered fixed costs. 

Other examples of fixed costs include: Telephone and internet costs and Loan payments Variable costs, however, do not remain the same and are usually directly linked to business activities. These are based on the volume of goods or services produced and the business’s performance. 

Examples of variable expenses include: Direct labor, Taxes and Operational expenses.

Variable costs can be challenging to manage as they can vary from month to month, increase or decrease quickly, and have more direct impact on profit than fixed costs. 

When it comes to fixed and variable costs, a clear understanding of each is essential for identifying the correct price level for goods and services. Understanding how costs can change with fluctuations in volume and output levels can help refine your overall business strategy.

Understanding the difference between fixed and variable costs can help a business owner identify economies of scale, which occur when a business makes cost reductions as it increases its level of production. By achieving economies of scale, a business can spread out fixed costs over a larger number of products or services and decrease variable costs in the process, resulting in significant cost advantages. 

Fixed and variable costs contribute to the ability of a business owner to get a clear picture of the cost structure of the business, which is why it’s important to understand the differences between these two cost types. 

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