What is fixed cost, and how does it differ from variable cost?

In business management, fixed costs refer to costs that do not change regardless of whether you produce or sell more or fewer goods. This is essential knowledge for managing finances wisely.

Fixed Costs Mean Costs That Do Not Change

Fixed Cost (Fixed Cost) are expenses that a business must pay every month or year, regardless of the company’s level of activity or sales volume. These are stable and predictable costs, crucial for budgeting and finding ways to increase profits intelligently.

Characteristics of Fixed Costs to Understand

Fixed costs have the special feature that they do not increase or decrease with production volume. Even if you double production, fixed costs remain the same. This makes financial planning easier.

Additionally, it helps make pricing products or services more accurate because you know how much needs to be covered by fixed costs. With this knowledge, you can set prices that are sufficient and still generate additional profit.

Common Examples of Fixed Costs in Business

• Rent: Rent for hotels, offices, or storage spaces paid monthly regardless of sales
• Salaries: Executives, management staff, or permanent employees with fixed salaries
• Insurance: Building insurance, material insurance, various risk insurances paid regularly
• Depreciation: The reduction in value of machinery, equipment, and assets used in the business
• Loan interest: If the company borrows money from a bank, interest payments are made regularly

Variable Costs Change According to Business Conditions

Variable Cost (Variable Cost) are costs that increase as production increases and decrease when production decreases. They provide flexibility for the business to control expenses.

Why Are Variable Costs Important for Planning?

Since variable costs follow the production volume, businesses can reduce costs when market demand drops and invest more when sales opportunities increase. This flexibility is not available with fixed costs.

Understanding variable costs allows businesses to accurately estimate the cost per unit, which helps in setting reasonable prices and achieving appropriate profits.

Examples of Variable Costs That Change with Conditions

• Raw materials and production inputs: The more you produce, the more raw materials you need to buy
• Direct labor wages: Production workers paid based on proportion or standard rates
• Energy and water costs: Higher when producing more, lower when producing less
• Packaging materials: Boxes, bags, tapes used to wrap products, increasing with the number of items
• Transportation and delivery costs: Increase when shipping larger quantities
• Sales commissions: Paid to sales staff based on sales volume

Comparing Fixed Costs and Variable Costs

Main Differences Business Must Know

Understanding the difference between these two types helps companies make rational investment decisions. For example, if variable labor costs are very high, it might be worthwhile to invest in machinery or automation to increase fixed costs but reduce long-term variable costs.

Fixed costs remain stable and predictable regardless of circumstances but lack flexibility. Examples include rent, executive salaries, and depreciation.

Variable costs follow activity levels, are flexible, but less predictable. Examples include raw materials, direct labor, and packaging.

Combining Both Costs for Better Planning

Calculating Total Costs and Their Benefits

By combining fixed and variable costs, you get the total business cost. This figure is useful for various decision-making processes.

Using Mixed Costs in Business Decisions

• Setting appropriate selling prices: Cover both fixed and variable costs, then add profit
• Planning production: Know how much to produce to break even and how much profit to aim for
• Evaluating investments: Analyze how new investments will affect costs
• Controlling costs: Identify which costs have increased significantly and explore ways to reduce them
• Assessing risks: Understand how market fluctuations will impact costs and profits

Summary

Fixed and variable costs are powerful tools for understanding a business’s finances—from production planning, pricing, expense control, to investment decisions.

Managing both types of costs effectively helps the business remain competitive and financially stable. Companies that understand their cost structure are better equipped to plan for the future intelligently.