Fixed costs and variable costs: Key variables that managers need to know

In the world of business management, understanding cost structure is an essential aspect that cannot be overlooked. Fixed costs and variable costs form the foundation for decision-making in pricing, profit estimation, and investment planning. Smart cost management does not mean cutting everything but knowing which costs to control and which to increase for growth.

Fixed Costs (Fixed Cost): Unavoidable Expenses

Fixed Costs (Fixed Cost) are expenses that a business must pay regularly regardless of how much it produces or sells. They are like burdens surrounding the company, whether there are customers or not.

Main characteristics of fixed costs

Fixed costs have important fundamental properties: First, they do not change with production volume. Whether you produce 100 units or 1,000 units, these expenses remain the same. Second, when it comes to financial planning, fixed costs are the most certain figures, helping companies forecast accurately.

Effective management of fixed costs involves strategic decisions, such as investing in assets at the outset to achieve appropriate fixed costs, and seeking ways to generate enough revenue to cover these baseline costs.

Common examples of fixed costs

• Rent: Office, factory, or store rent paid monthly or annually on a regular basis
• Salaries: Regular wages for full-time personnel that are independent of sales performance
• Insurance: Business coverage against various risks paid as scheduled
• Depreciation of assets: Cost allocation of machinery, buildings, and equipment over time
• Interest on debt: Regular expenses from borrowing capital

Variable Costs (Variable Cost): Expenses that fluctuate

Unlike fixed costs, which are steady and predictable, Variable Costs (Variable Cost) are expenses that dance in rhythm with production and sales. As the business expands, these costs increase; when it contracts, they decrease accordingly.

Key characteristics of variable costs

Variable costs are flexible: they increase proportionally with the production volume. If you produce 50% more, variable costs will also increase by about 50%. This makes variable costs crucial because they represent the smallest controllable number through production management.

Typical examples of variable costs in normal circumstances

• Raw materials and components: Material costs that increase with production volume
• Direct labor: Wages of workers on the production line, depending on workload
• Electricity and water: Utility costs that vary with operational activity
• Packaging costs: Costs of boxes, bags, or packing materials that increase with production
• Shipping: Expenses for delivering products to customers, related to sales volume
• Sales commissions: Bonuses paid to sales teams based on the number of items sold

Comparing Fixed and Variable Costs

To illustrate clearly, imagine opening a coffee shop:

Fixed costs include your rent (500,000 THB/month), manager’s salary (30,000 THB/month), and insurance (5,000 THB/month). Total fixed costs are 535,000 THB per month, regardless of whether you sell 100 cups or 5,000 cups of coffee that month.

Variable costs include coffee quality, sugar, milk, cups, paper cups, and delivery. As sales increase, these costs will rise accordingly.

This is why understanding both types of costs is vital for decision-making: if demand is high (high demand), you might decide to invest in new fixed assets to expand production. Although fixed costs increase, the expectation is that revenue will grow more significantly.

Leveraging Total Cost Analysis

When combining fixed and variable costs, you get total cost, a powerful decision-making tool:

• Setting appropriate prices: You need to know the total cost to choose a selling price that covers everything and generates profit
• Production planning: Knowing how many units to produce to reach the (break-even point) helps set realistic goals
• Investment evaluation: Before purchasing machinery or investing in new assets, you should calculate whether such investments will reduce variable costs and whether the additional revenue will justify the expense
• Adjusting decisions based on circumstances: When market conditions change, you can adapt strategies, such as negotiating with suppliers to reduce variable costs or increasing fixed costs to improve production efficiency

Key Takeaways

Fixed costs and variable costs are two sides of the same coin. Both determine a business’s competitiveness and financial stability. Understanding their differences is not just theoretical but a practical tool to better manage your business.

Smart managers will not blindly cut fixed costs; investing in the right fixed assets can reduce variable costs and improve long-term efficiency. Meanwhile, controlling variable costs must be an ongoing effort to ensure profit per unit remains stable.

This approach forms the foundation for business growth, stability, and sustainable competitiveness in a constantly changing market.