## Fixed Cost and Variable Cost: Once You Understand Them, Your Business Can Avoid Many Pitfalls

For business owners, categorizing costs is not just about bookkeeping. It’s about survival. Fixed costs and variable costs are two factors that determine whether a business will thrive or fail, regardless of how well sales are doing.

In this article, we will decode what **Fixed Cost (Fixed Cost)** entails and how it relates to Variable Cost, so you can make informed decisions about business expansion, pricing, and investment wisely.

## What Are Fixed Costs (Fixed Cost)

**Fixed costs** are expenses that a business must pay every month or year, regardless of how many units are sold or if nothing is sold at all. Whether the factory is operating at full capacity or standing still without producing anything, these costs continue to accrue.

The reason fixed costs are important for planning is that they are stable. Businesses can predict how much money they need to cover these costs to keep operations running. This helps in estimating the break-even point, setting appropriate selling prices, and planning cash flow for several months ahead.

### Fixed Cost Includes: Details of Fixed Costs in Business

**Rent** - Whether you sell 0 or many units this month, the monthly rent for your office or factory remains the same. Whether inventory is full or sold out, rent must be paid.

**Salaries** - Regular employees with contracts must receive their salaries every month, regardless of whether the business is profitable or not.

**Depreciation of Assets** - Machinery, equipment, ovens, refrigerators—all these lose value daily. You need to set aside money for replacements in the future.

**Insurance** - Building insurance, product insurance, truck insurance, etc., must be paid regularly to mitigate risks.

**Loan Interest** - If the business has borrowed money from a bank or friends, interest payments are due periodically. The amount of interest does not change with sales volume.

**Basic Utilities (Basic Utilities)** - Even without production, you still incur costs for maintaining the space, cooling, lighting, etc.

**Regular Advertising** - If you pay monthly for advertising to keep your brand visible to customers, that is a fixed cost.

A key characteristic of fixed costs is that they are inflexible. They depend on long-term agreements or legal obligations. The business cannot easily change them at will.

## What Are Variable Costs (Variable Cost)

**Variable costs** are expenses that increase or decrease in proportion to production and sales volume. The more you sell, the higher the costs; the less you sell, the lower the costs.

The importance of variable costs lies in their flexibility. When the market downturns, a business can reduce production, cut costs, and avoid accumulating expensive inventory. Conversely, when the market is good, the business can ramp up production and quickly increase revenue.

### What Are Variable Costs: Details of Costs That Fluctuate with Sales

**Raw Materials** - All materials used to produce goods. More production means more raw materials used; less production means fewer raw materials.

**Direct Labor** - Workers paid per piece or per hour in the production room. The more products to make, the higher the labor costs.

**Production Energy** - Electricity for machinery, gas for ovens, cooling water, etc., which increase with production volume.

**Packaging and Others** - Boxes, product labels, other packing materials, which increase with the number of units sold.

**Shipping** - Delivery costs to customers. The more you ship, the higher the shipping costs.

**Sales Commissions** - Payments to sales teams or agents based on sales proportion. The more you sell, the higher the commissions.

The characteristic of variable costs is that they can be quickly reduced. If the market is slow, production can be cut, factories can be shut down temporarily, and costs will decrease immediately.

## Fixed Costs vs. Variable Costs: The Difference Business Must Understand

| Criteria | Fixed Cost (Fixed Cost) | Variable Cost (Variable Cost) |
|---|---|---|
| Changes | Do not change with sales volume | Change with production volume |
| Examples | Rent, salaries, interest | Raw materials, wages, packaging |
| Flexibility | Inflexible; must be paid regardless | Flexible; can be adjusted |
| Timing | Paid immediately after signing | Paid when production occurs |
| Impact on Profit | Affects the break-even point (Break-even point) | Affects profit per unit |

An example of investment decision: If the direct labor cost is very high, management might decide to invest in automation machinery, which will increase fixed costs (depreciation of machinery) but significantly reduce variable costs (labor). The result is lower total costs and higher profit per unit.

## Using Cost Analysis for Business Decision-Making

By combining fixed and variable costs, a business gains an overall picture of total costs, which aids in critical decision-making:

**Pricing** - Set a price higher than fixed cost + variable cost per unit to ensure profit.

**Break-even Point (Break-even Point)** - How many units need to be sold to cover all costs? If fixed costs are high, more units must be sold to reach this point.

**Next Month’s Revenue Planning** - Knowing fixed costs in advance allows calculation of the minimum revenue needed to avoid losses.

**Business Expansion Decisions** - Should you invest in more machinery? Fixed costs will increase, but variable costs per unit will decrease. This decision requires analyzing both sides.

**Cost Control** - Identify which costs are too high and find ways to adjust, such as renegotiating rent or sourcing cheaper raw materials.

## Summary

**Fixed costs** are ongoing financial burdens that are predictable, making planning easier but offering little flexibility. **Variable costs** change with production, providing flexibility but potentially increasing total costs when sales are high.

Understanding both types helps managers make smarter decisions, whether setting prices, investing, expanding, or adapting to market conditions. Businesses that grasp these cost concepts are more likely to survive and grow.