As you hopefully know, there are certain costs that come with running any business. Typically, a business deals with two types of costs: fixed costs and variable costs. If you hope to be successful in running a business, you should have an understanding of what these costs mean to your business’s overall growth and profitability.
Here, we’ll look at fixed costs and five fixed cost examples, while also touching briefly on variable costs and their implications.
What Are Fixed Costs?
A fixed cost is a cost that does not change based on the sales of a company. In other words, a business has committed to these costs, and the costs have nothing to do with the business’s volume of production.
Fixed costs are generally consistent, although they may vary slightly depending on what the specific cost is. For example, utilities tend to be a fixed cost, but if you are consistently talking on the phone with international clients or using air conditioning more frequently as production ramps up during the hot summer months, you will probably see a fluctuation in your utilities bill. In this case, the utilities in question are variable costs.
What Are Variable Costs?
It is important to define variable costs to better understand fixed costs and how the two relate to each other. Variable costs are costs that change based on production output. Therefore, as the volume of production and output increases, variable costs will also increase. On the other hand, when fewer products are produced, variable costs will be lower.
Raw materials, labor, and distribution costs are all examples of variable costs.
The Impact Of Fixed Costs On Profitability
Depending on what sort of business you run, you may have high fixed costs or low fixed costs. But what can this tell you, if anything, about your business’s profitability?
Businesses that have high fixed costs tend to experience skyrocketing profits. Let’s say that you run a commercial printing operation. Since the machinery and the production space are likely expensive, you will be paying a lot in fixed costs. For a period of time, no matter how many printing jobs you complete, you will notice that your monthly payments will still be high. Once you do pay off your fixed costs though and reach your breakeven point, you will see a surge in profits since your costs of production will end up being lower.
Low-fixed-cost companies, on the other hand, have high variable costs, so the amount of profit generated by those companies stays fairly consistent throughout.
5 Examples Of Fixed Costs
There are a number of fixed costs you could deal with at any given time, but here are five fixed cost examples that you are most likely to see.
Amortization is the practice of paying off the cost of an intangible asset over a period of time until that asset has expired. Examples of intangible assets include patents, trademarks, franchise agreements, and any proprietary processes.
Depreciation is similar to amortization, except it deals with tangible assets, such as buildings, equipment, and vehicles. It is calculated by subtracting the asset’s resale value from its original cost, and this cost is divided over the asset’s lifespan. Some fixed assets can be paid out on an accelerated basis, which means that the majority of the asset’s cost can be paid early on.
3. Real Estate
Whether you run your business out of your home (though you may be able to claim a tax deduction on this) or rent a facility, you need to pay for the physical space where you conduct your business.
Naturally, you need to pay your employees, and usually these will be fixed payments to some degree. The only real exception is commission-based pay, which is variable since it is dependent on sales volume.
Utilities can actually either be mixed costs or variable costs. For example, Internet bills do not fluctuate at all based on production volume. But, if you are using electricity more frequently to make a certain product, this utility is then tied to the production process and can, therefore, be considered a variable cost.
Some other fixed costs include insurance, debt service, licensing fees, and equipment and vehicle lease payments.
Always Keep In Mind How Much You Are Praying In Fixed Costs
As mentioned before, just because a cost is “fixed,” this does not mean that it is not subject to change. A cost is only fixed in the sense that it does not relate to production. With that in mind, always be wary of how much you are paying for your fixed costs. If the rent is too high, consider shopping around for more affordable facilities. If you are paying out too much in utilities, maybe you should only be considering the necessities.
Remember, the goal of any business is to be profitable and that fixed costs are tied to your business’s ability to generate profits.