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Fixed Cost vs Variable Cost

Fixed Cost vs Variable Cost

When running a business, it’s very important to understand how your costs behave. Costs can be broken down into two main ones: fixed and variable costs. These form the crux of understanding cost and how much it would take to keep the business running, as well as how much needs to be sold to make some profit.

Let’s understand the difference between fixed cost and variable cost in simple terms.

What are Fixed Costs?

Expenses that are fixed regardless of production or sales volume are known as fixed costs. Whether your company is experiencing rapid growth or a sluggish month, these expenses are equal. They are essentially bound.

Here are some examples:

  1. Rent: If you rent an office, warehouse, or storefront space, your rent does not change month to month, regardless of the quantity you’re selling.
  2. Salaries: Fixed-salary employees receive the same amount every month, regardless of how much the company produces or sells.
  3. Depreciation: The value of the equipment or machine decreases with time, but this expense is levelled over the years and is also irrelevant to the production amount.
  4. Insurance: Whether you’re doing great or struggling, your business insurance premium stays fixed.

Key Points about Fixed Costs:

  1. They don’t change: You pay the same monthly amount, no matter what.
  2. Predictable: You can always count on these costs being the same.
  3. Long-term: Such costs tend to stay for a relatively long time.

What are Variable Costs?

On the other hand, variable costs refer to costs that go up and down with how much you produce or sell. Such costs increase if you make more and decrease when you produce less. In other words, they fluctuate with your business activity.

Some standard variable costs include:

  1. Raw material: If producing goods, the more you manufacture, the more materials are required.
  2. Labour: Workers paid by the hour or per unit of work increase costs with increased production.
  3. Sales commissions: You pay commissions based on sales. The more you sell, the more you will pay in commissions.
  4. Utilities: For some businesses, the more you produce, the more energy and resources you use.

Key Points about Variable Costs:

  1. They change with production: The more you make or sell, the higher your costs.
  2. Flexible: These costs can be adjusted depending on how much you’re doing.
  3. Short-term: You can often control or reduce these costs in the short term by adjusting production.

Difference Between Fixed and Variable Costs

Understanding the difference between fixed cost vs variable cost is important for effective financial planning and resource management. Here’s a quick comparison:

AspectFixed costsVariable costs
DefinitionCosts that remain constant regardless of outputCosts that change with production or sales volume
ExamplesRent, salaries, insuranceRaw materials, fuel, hourly wages
BehaviourStays the same over timeIncreases or decreases with activity levels
Short-Term ControlHard to adjustEasier to manage or reduce

How Fixed and Variable Costs affect Profitability

The combination of fixed vs variable costs greatly influences your business’s profitability. Let’s examine the effects of these expenses.

Profitability with fixed costs:

  1. High fixed costs: You must sell many goods to cover your company’s high fixed costs. You will lose money if you don’t sell enough.
  2. Low fixed costs: Breaking even is simpler if your fixed costs are low. You don’t need as many sales to pay for your basic expenses.

Profitability with variable costs:

  1. High variable cost: If variable costs are on the higher side, it suggests that you incur more to create each unit, which makes being profitable difficult when you produce at a higher rate because it only gets more costly.
  2. Low variable costs: If your variable expenses are low, you can keep production costs down, making it easier to profit as sales increase.

How Fixed and Variable Costs Work Together

Together, fixed and variable costs make up the business’s cost. You need to add the two together to determine how much it costs to run your business.

For instance, if the fixed rent is Rs. 80,000 a month and the materials cost Rs. 400 per unit (variable), total costs will vary with the number of units you produce or sell.

Break-even Analysis: Why it’s important

The level at which all of your expenses—both fixed and variable cost—are covered by your entire revenue is known as the break-even point. It is the sales volume required to meet the costs without turning a profit or losing money.

Here’s a quick calculation for it
Break-even volume= Fixed costsPrice per unit-Variable cost per unit

In plain terms:

  1. The top part of the formula is how much you need to cover your fixed costs.
  2. The bottom part is your contribution margin, or how much you earn after covering the variable costs of making a product.

Once you hit that break-even point, everything you make beyond that is profit.

Final thoughts

With the right financial support, managing business costs is much easier. We at Tata Capital provide solutions to all your needs, from online business loans to customised personal loan plans. Our mobile app and website are easy to use, as they help you find out what options you have, calculate your eligibility, and apply in just a few steps.


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FAQs

What is an example of a fixed cost?

Rent is a classic example of a fixed cost. Whether your business is booming or slowing down, your office, warehouse, and store rent will remain the same.

Is labour a fixed or variable cost?

Labour can be fixed (salaried employees) or variable (hourly workers), similar to a business loan interest rate, which can also be fixed or variable depending on the loan type.

Is fuel a fixed or variable cost?

Fuel is generally a variable cost because the cost goes up with more production, transportation, or usage.

What are the four types of cost?

There are four types of cost: fixed, variable, semi-variable (a combination of fixed and variable), and direct (linked to production).
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