## Fixed Costs vs Variable Costs: Why Companies Need to Know the Difference

When planning finances or setting product prices, the first problem most organizations face is not knowing which costs are "permanent" and which can change. This confusion often leads to poor decisions and ultimately losses.

In reality, all costs in a business fall into only two main categories: **Fixed Costs** and **Variable Costs**. Understanding the difference between these two is fundamental to effective financial management.

## Costs that "Follow You" No Matter What

**Fixed Costs (Fixed Cost)** are expenses that the organization must pay in full every month, quarter, or year, regardless of how many products are sold, produced, or if the business is not operating at all.

Fixed costs are often related to the long-term obligations of the company, calculated as follows: lease agreements for office space, salaries that must be paid monthly, interest on loans that remains fixed, etc., must be funded regardless of activity level.

### Fixed Cost Examples in Concrete Terms

- **Rent**: Whether activity is 0% or 100%, rent remains the same
- **Salaries of full-time employees**: If hiring full-time staff, they must be paid monthly
- **Insurance and registration fees**: Regular payments to keep the company compliant
- **Asset depreciation**: Buildings, machinery recorded with fixed monthly depreciation
- **Loan interest**: If borrowed, interest payments are made as per the agreement

What makes fixed costs "fixed" is that they do not depend on sales volume or production levels. The graph is a straight horizontal line, meaning whether the business expands or contracts, these costs stay the same.

## Costs that "Stretch" with Production Volume

**Variable Costs (Variable Cost)** are the opposite of fixed costs. They are expenses that change directly in proportion to production or sales.

The more an organization produces, the higher the variable costs; the less it produces, the lower the costs. This is why businesses may choose to "scale" according to customer orders.

### Real-world Examples of Variable Costs

- **Raw materials**: Producing one item requires a certain amount of material; producing ten requires ten times that amount
- **Direct labor**: Workers paid per unit or per hour based on output (such as piece-rate or hourly wages)
- **Energy and water costs**: Higher production uses more electricity and water
- **Packaging costs**: Each product needs packaging, which varies with quantity
- **Shipping and delivery**: Sending one box costs a certain amount; sending 100 boxes costs 100 times that amount
- **Sales commissions**: Some businesses pay commissions based on sales volume; more sales mean higher commissions

Variable costs are more "flexible" because they can be adjusted according to market demand.

## Why Businesses Must Distinguish Between "Fixed" and "Variable" Costs

### Pricing Decisions

Knowing the fixed and variable costs per unit allows calculating the price needed to cover costs and generate profit.

### Production Planning

Understanding variable costs helps organizations know how total costs will change if production increases by 50%, enabling accurate planning.

### Investment Decisions

When considering investing in new machinery, businesses compare whether "fixed costs increase" but "variable costs decrease"—is it worthwhile?

### Break-even Point (Break-even point)

By dividing fixed costs by profit per unit (price minus variable cost per unit), one can determine how much needs to be sold to avoid losses.

## Combining Both Costs

In reality, organizations work with **Total Costs**, which equal Fixed Costs + Variable Costs.

Analyzing total costs this way provides clearer insights into:

- **What should be the selling price** to cover costs and make a profit
- **How much to sell** to break even (break-even point)
- **The ratio of fixed to variable costs**, reflecting the business structure
- **How profit will change** if market conditions shift

For example, a company with fixed costs of 100,000 THB per month and variable costs of 50 THB per unit, setting a price of 150 THB per unit, yields a profit of 100 THB per unit. To break even, it must sell at least 1,000 units (100,000 ÷ 100).

## Choosing a Smart Cost Structure

Some companies opt for higher fixed costs (such as investing in automated machinery) to significantly reduce variable costs, leading to higher profits as production increases.

Others prefer lower fixed costs (such as renting flexible workspaces) to reduce risk, accepting higher variable costs.

There is no "correct" choice; it depends on the nature of the business, growth potential, and investment capacity.

## Summary

**Fixed Costs** are the constant amounts that must be paid periodically, regardless of sales. They are usually related to assets and long-term contracts.

**Variable Costs** change with production volume; the more produced, the higher the costs.

Smartly distinguishing and combining these costs for analysis helps businesses make better decisions—from pricing and production planning to risk assessment and future opportunities.

Businesses that understand fixed and variable costs are better equipped to control finances and achieve sustainable growth.