## Fixed Cost vs Variable Cost: The Financial Basics Every Entrepreneur Must Understand

Running a business is all about avoiding "confusing accounts." Many novice entrepreneurs spend money but fail to distinguish between fixed costs (Fix Cost) and variable costs, ultimately damaging profitable projects.

In essence, these two concepts boil down to one thing—**one type of expense cannot be avoided, while the other can be controlled**. Once you grasp this logic, your business decisions will be much more effective and less prone to pitfalls.

## What is Fixed Cost (Fixed Cost)?

Fixed costs are expenses that you pay "every day, regardless of whether you work or not."

For example, renting an office means the landlord charges rent every month, whether your business is booming or slow. Hiring a full-time employee means paying their salary monthly, even if there’s little business in a given month.

**The core characteristic of fixed costs is: the amount to be paid does not depend on output.**

### What does fixed cost include?

- **Facility expenses**: Office rent, warehouse rent, factory premises
- **Fixed salaries**: Salaries for full-time employees, management compensation (fixed monthly or yearly)
- **Insurance costs**: Business property insurance, liability insurance, etc.
- **Depreciation of equipment**: Machinery, vehicles, and other fixed assets
- **Loan interest**: Interest payments on business loans
- **Professional service fees**: Accounting, legal consulting, and other annual fixed expenses

The trouble with fixed costs is—**they do not decrease even if your sales decline**. That’s why many businesses still face pressure during off-peak seasons.

## What is Variable Cost?

Variable costs are exactly the opposite—**the more you produce, the more you spend; if you stop production, these costs are saved**.

For example, manufacturing a product requires raw materials. Producing 100 units costs the price of 100 portions of raw materials; producing 1,000 units costs 1,000 portions. If you halt production, these costs are eliminated.

### What does variable cost include?

- **Raw materials and components**: All materials directly used in production
- **Direct labor costs**: Wages for hourly workers, assembly line staff (costs based on output)
- **Energy consumption**: Electricity, gas, and other utilities during production
- **Packaging materials**: Product packaging, shipping materials, labels
- **Logistics and delivery fees**: Shipping costs that vary with sales volume
- **Sales commissions**: Personnel expenses based on sales revenue

**The advantage of variable costs is their flexibility**—as sales decrease, these costs can also be reduced, easing cash flow pressure for the business.

## Fixed Cost vs Variable Cost: What’s the Difference?

These two concepts are often confused, so let’s compare directly:

| Dimension | Fixed Cost | Variable Cost |
|--------------|--------------|--------------|
| **Does it change with output?** | No | Yes, proportionally |
| **Controllability** | Low, hard to adjust immediately | High, flexible adjustments possible |
| **Forecasting difficulty** | Easy to predict | Requires sales volume forecasts |
| **Typical items** | Rent, salaries, depreciation | Raw materials, packaging, commissions |
| **Risk characteristics** | Risk concentrated; sales decline increase pressure | Risk dispersed; tied to sales volume |

**Key insight**: Industries with high fixed costs need to generate sales beyond a certain threshold (called the "break-even point") to turn a profit. Conversely, industries with high variable costs must focus on procurement efficiency and production effectiveness.

## Why Are These Concepts Important to You?

### 1. **Pricing Decisions**
You must cover fixed costs first before making a profit. For example, if a clothing factory’s fixed monthly cost is 100,000 yuan, selling only 100 pieces at a price that includes 1,000 yuan profit per piece is unrealistic. You need to ensure your monthly sales volume can cover that 100,000 yuan fixed cost.

### 2. **Capacity Planning**
Understanding your cost structure allows you to determine the most efficient production volume. Sometimes, increasing output can lower the unit cost (fixed costs are spread over more units).

### 3. **Financing and Cash Flow Management**
Fixed costs require ongoing cash outflows. If your business has seasonal fluctuations, you must reserve enough cash to survive the slow periods when fixed costs still need to be paid.

### 4. **Investment Decisions**
Deciding whether to buy expensive automation equipment involves weighing "increasing fixed costs" against "reducing variable costs."

## Real-World Case Studies

**Case A: Restaurant Business**
- Fixed costs: Rent, chef salaries, business license fees
- Variable costs: Ingredients, disposable tableware, delivery fees

During off-peak seasons, rent and salaries still need to be paid. That’s why many restaurants choose to stay open for dinner—closing would lead to even greater losses.

**Case B: Software Company**
- Fixed costs: Office rent, basic salaries for developers, server maintenance
- Variable costs: Marketing, customer support, additional server costs

As user numbers grow, variable costs increase, but fixed costs remain largely unchanged. This is why SaaS models can be highly profitable.

## How to Optimize Your Cost Structure?

### Strategies to reduce fixed costs:
- Switch from purchasing to leasing (turning capital expenditure into operational expense)
- Outsource certain functions (reducing permanent staff)
- Share office space or benefit from industrial park discounts

### Strategies to control variable costs:
- Negotiate long-term contracts and bulk discounts with suppliers
- Optimize production processes for efficiency
- Improve product quality to reduce waste and rework

### Structural Optimization:
- Some companies choose to increase fixed costs (buy automation equipment) to significantly lower variable costs
- Such investments can greatly improve profit margins when production volume is sufficient

## Summary

**The difference between fixed costs (Fix Cost) and variable costs fundamentally determines a company's survival.**

- Companies with high fixed costs need to ensure sufficient sales volume to stay afloat, but once the break-even point is reached, profits can accelerate.
- Companies with high variable costs are more resilient to risk but have limited profit margins influenced by raw material prices and efficiency.

What is the ideal cost structure? There’s no one-size-fits-all answer, but understanding your numbers is crucial for long-term survival in a competitive environment.

Whether you’re starting a business, investing, or managing a company, these two concepts form the foundation of decision-making. Mastering them elevates your understanding of business to a new level.