7 Differences between Fixed and Variable Costs

7 Differences between Fixed and Variable Costs

The differences between fixed and variable costs are important for business owners and financial managers to understand well. These two types of costs reflect different characteristics of business expenses.

Not only that, the difference between the two has a huge impact on a business’s financial structure and managerial decision-making. To better understand, let’s look at the differences between fixed costs, as well as the types of costs and their examples in this article!

Definition of Fixed and Variable Costs

Before discussing the differences between both, let’s first understand the concepts of fixed and variable costs below.

1. Fixed Cost

Fixed costs refer to cost elements that are consistent and unaffected by fluctuations in production or sales volume. These costs include production facility rent, property taxes, salaries, interest payments, and insurance.

To put it simply, fixed costs are costs that businesses must pay regardless of how much or how little a product or service is produced. Fixed costs provide stability in business financial planning. Not only that, this cost is a component that needs to be managed efficiently.

2. Variable Costs

Variable costs are costs that directly correlate with the amount of goods or services produced. When production volume increases, variable costs increase, and vice versa. It’s worth noting that production costs differ between industries, depending on the production and sales of your business.

For example, variable costs involve raw materials or direct labor that are incurred according to production needs. The flexibility of variable costs makes them responsive to changes in market or production needs.

Differences Between Fixed and Variable Cost

In business finance, there are differences between fixed and variable costs that have a deep involvement in a business’s financial strategy. Here are seven differences between both costs.

1. Effect on Selling Price

Fixed costs do not directly impact the selling price per unit of product or service. In contrast, variable costs have a strong correlation with pricing. When variable costs rise, especially due to an increase in raw material costs or direct labor wages, it can have a direct impact on the profit margin per unit.

2. Time of Expenditure

Fixed costs tend to be fixed over a while and are not affected by daily or monthly operational cycles. On the other hand, variable costs show greater flexibility and are affected by fluctuations in production or direct sales.

3. Nominal Amount

The nominal amount of fixed costs is often greater than variable cost payments. This is due to the fixed nature and consistency of fixed costs, such as rental costs of production facilities or management salaries. Meanwhile, payments for variable costs are generally smaller and can be adjusted according to the company’s financial condition.

4. Reporting Intensity

For reporting intensity, variable cost reports will usually be issued more frequently, such as daily, weekly, and monthly according to the flow of products in and out. In contrast, the intensity of fixed cost reporting is very rare. This report is usually issued in a longer time interval.

Read Also: Regarding Sales Reporting App

5. Operating Cycle

Fixed costs are generally long-term and do not change in the daily or monthly operational cycle. Variable costs, on the other hand, are directly related to the operational cycle and change according to production needs.

6. Influence of Production Costs

Total variable costs increase or decrease as operational activities increase or decrease. Meanwhile, fixed costs tend to be stable, although the company may incur variable costs.

7. Assessment Focus

Fixed costs that tend to be stable over a long period are usually evaluated by considering the time aspect. On the other hand, variable costs are assessed based on the amount of production thus creating responsiveness to fluctuations in operational activities.

Read Also: What is ERP in Office Administration?

Types of Fixed Costs

Fixed costs are an important component of strategizing and the financial sustainability of your business. The following are some types of fixed costs and examples.

1. Salaries

Salary is one type of fixed cost that is consistent in every pay period. While the company’s operational activities may fluctuate, salary payments for employees remain stable to create a foundation of labor sustainability.

2. Rental Payment

Rental costs are closely related to the use of certain facilities for the company’s daily operations. While the value of the property or facility may not change, the rental payment is constant over some time, such as monthly or annually.

3. Land and Building Tax

Property taxes, such as land and building taxes, are another example of fixed costs. Although production and sales increase or decrease, the payment of these taxes remains consistent within a certain predetermined time.

4. Insurance

Insurance costs, both for company assets and employee health insurance, are included in fixed costs. Insurance premium payments are regular and independent of possible production dynamics.

5. Water and Electricity Costs

Although utility costs, such as electricity or water, may vary, they are often considered fixed costs. This is because the payment of these costs is regular and stable over some time.

Types of Variable Costs

Variable costs have a direct impact on business profits and can be identified in each unit of product or service produced. Here are the types of variable costs and examples.

1. Sales Commission

Sales commissions relate to rewards given to salespeople or sales agents based on the number of sales they make. For example, if a salesperson successfully sells a company’s product or service, a sales commission will be given in recognition of their contribution to the sale.

2. Direct Labor Costs

Direct labor costs include salaries and benefits provided to workers who are directly involved in the production process or service provision. These costs are different from salaries and are variable as they will increase as production increases.

3. Raw Material Costs

Raw material costs refer to the costs associated with the materials used in the production process. These raw material costs tend to fluctuate according to the level of production. For example, in the food industry, there are raw material costs such as flour, sugar, and other ingredients used to make products.

4. Product Distribution Costs

Product distribution costs involve expenses associated with the physical distribution of products from manufacturers to end consumers. For example, product shipping costs, warehousing costs, and transportation costs.

5. Overhead Costs

Overhead costs refer to costs that are not directly related to the production process or are often called costs of miscellaneous or additional expenses. Although most overhead costs are fixed, there are also elements of overhead that are variable. For example, production utility costs may increase as production activity increases.

At this point, you finally understand the difference between fixed and variable costs, from the time of expenditure, nominal amount, relationship with production costs, to the focus of assessment.

Fixed costs that are constant can provide a stable basis. Variable costs, on the other hand, adjust to changes in operational activities, providing flexibility in market fluctuations.

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Differences between Fixed and Variable Costs, 7 Differences between Fixed and Variable Costs, Advance Innovations

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Published date :

14 March 2024