Fixed costs vs. variable expenses: The difference every business owner needs to know

If you are a business owner, managing your finances well requires understanding how your business expenses are categorized. This knowledge will help you plan your spending and set product prices accurately. In this article, we will explore the differences between Fixed Cost (Fixed Cost) and Variable Cost (Variable Cost), and why they are important for your business management.

What is Fixed Cost? It Remains Constant

Fixed costs refer to expenses that a business must pay continuously, regardless of how much you sell or whether you are marketing or not. These costs stay the same because they are long-term commitments you have taken on.

Key characteristics of fixed costs

• Do not change with sales volume Whether you sell 1,000 units or 100 units this month, these costs remain the same.
• Must be paid even if there is no profit Even in a loss-making month, fixed costs still need to be paid.
• Affects pricing decisions When setting your selling price, you need to cover fixed costs and generate profit.

Examples of fixed costs commonly found in businesses

• Rent for shop/factory/office - Paid monthly, regardless of sales performance
• Salaries of full-time employees - Paid according to employment agreements
• Business insurance - Maintained to protect against risks
• Depreciation of machinery and premises - For safety and quality assurance
• Interest on loans - If you have borrowed money, interest payments are due monthly

What is Variable Cost? It Fluctuates with Production

Variable costs (Variable Cost) are expenses that change in proportion to your business’s production volume or sales. The more you sell, the higher these costs; the less you sell, the lower they become.

Key characteristics of variable costs

• Vary with sales and production levels The more you produce, the more raw materials are needed, increasing costs.
• Flexible You can control these costs by adjusting your production volume.
• Related to daily operations They arise from your core business activities.

Examples of variable costs in various businesses

• Raw materials and components - Producing more products requires purchasing more raw materials.
• Piece-rate or contract labor - Costs depend on the number of units produced.
• Electricity and water bills - Used in manufacturing; higher production means higher utility costs.
• Packaging and wrapping materials - Needed according to the number of products sold.
• Shipping and delivery costs - The more you ship, the higher the expenses.
• Sales commissions - If sales are high, commissions paid to sales staff increase accordingly.

Comparison: Fixed Cost vs. Variable Cost

Understanding these differences helps business owners manage their finances better. When you know which costs are fixed and which are variable, you can plan your cash flow, set appropriate selling prices, and estimate how much you need to sell to break even.

Managing Both Types of Costs

When fixed costs increase (such as higher rent), many businesses choose to invest in machinery to reduce variable costs, meaning fixed costs go up but variable costs decrease.

Another approach is effective management:

• Fixed costs - Negotiate lower rent or switch to a membership model instead of full-time staff.
• Variable costs - Negotiate better prices for raw materials or find new suppliers.

Summary

Fixed Cost (Fixed Cost) are expenses that do not change and must be paid regularly, making them suitable for budgeting.

Variable Cost (Variable Cost) are expenses that fluctuate with production volume, offering flexibility in management.

Successful businesses understand both types and manage them well to set optimal selling prices, keep costs at appropriate levels, and ultimately generate enough profit to sustain growth.