What’s a Fixed Cost?
A business expense’s fixed cost doesn’t change regardless of production or sales. Common fixed costs include rent, interest, insurance, depreciation, and property taxes.
Fixed costs are indirect because a company doesn’t produce anything. Shutdowns reduce fixed costs. These costs are part of two types of business expenses that add up. Variable cost.
Fixed Costs
The income statement lists indirect, direct, and capital costs as short- or long-term liabilities. Companies have fixed and variable costs. Cost structure analysis examines fixed and variable costs. Costs affect profitability.
Fixed costs remain constant. Contracts or schedules set fixed expenses. These are the fundamental business costs. Fixed costs remain constant throughout an agreement or cost schedule.
Operating profit comes from indirect expense allocation of fixed costs. Indirect expenses include depreciation. Companies depreciate assets with declining values. Depreciation is used to expense manufacturing assembly line machinery. Management salaries are another major indirect cost.
Balance sheet and cash flow statements include income statement fixed costs. Balance sheet fixed costs can be short- or long-term liabilities. The cash flow statement shows fixed-cost payments. Lowering fixed costs can reduce expenses and boost profit for a company.
Companies can allocate fixed costs across their income statements. An industry’s fixed versus variable cost ratio and allocation can vary.
Fixed vs. Variable Cost
As mentioned above, fixed costs are recurring business expenses. Fixed expenses are usually negotiated for a specific period. Still, they cannot decrease per unit when associated with the direct cost portion of the income statement, fluctuating in the breakdown of costs of goods sold.
Variable costs are production-related. Business output determines them. Production and sales affect these costs. Production raises variable costs. These expenses decrease when production decreases. When analyzing a company’s costs, it’s crucial to compare them to those in its industry.
Labor, utilities, materials, shipping, and commissions are variable costs.
Fixed-cost factors
Cost-per-unit analysis can include fixed and variable expenses. COGS can include both types of costs. Gross profit is the sum of all production costs minus revenue. Cost accounting varies by company and cost.
Large-scale producers may benefit from economies of scale. Fixed costs decrease per unit as production increases, improving economies of scale. Fixed production costs like direct labor and rent vary by company.
Hybrid expenses combine fixed and variable costs. Semi-variable costs have fixed and variable components and are fixed for a certain production level. Costs vary after this threshold. Repairs and electricity are common semi-variable costs.
Special Conditions
Fixed expenses can calculate the breakeven point and operating leverage.
Breakeven Analysis
The breakeven analysis uses fixed and variable costs to find a production level where revenue equals costs. Cost structure analysis may require this. Breakeven production is calculated by:
Breakeven analysis helps companies decide on fixed and variable costs. The break-even analysis also affects a company’s product price.
Working Leverage
Cost structure management includes operating leverage. Operating leverage depends on a fixed-to-variable cost ratio. Fixed costs increase operating leverage. Operating leverage formula:
formula
Operating leverage increases profit per unit.
Cost Management Ratios
Most companies use cost structure statements and dashboards to track their costs.
Independent cost structure analysis helps a company understand how fixed and variable costs affect different parts of the business and the whole business. Cost analysts at many companies monitor and analyze fixed and variable costs.
To determine production fixed costs, divide fixed costs by net sales.
Examples of Fixed Cost
Rental and lease payments, certain salaries, insurance, property taxes, interest, depreciation, and some utilities are fixed costs.
A new business might start with rent and management salaries. All companies monitor fixed-cost agreements. These fixed costs change independently of production levels. New contracts or schedules can cause changes.
All Fixed Costs Sunk?
In financial accounting, sunk costs are fixed costs. Sunk costs are irrecoverable.
Unsunk fixed costs are easy to imagine. Equipment may be resold or returned at the purchase price.
Businesses and individuals incur sunk costs. Someone might drive to the store to buy a TV but decide not to when they arrive. However, the customer must refrain from demanding that the gas station or electronics store reimburse them for the mileage.
Accounting for Fixed Costs?
Business fixed costs include operating and overhead costs. Fixed costs are indirect production costs, unlike assembly parts. However, they affect production costs. Fixed costs are depreciated instead of expensed.
Variable vs. fixed costs?
Variable costs directly affect production, unlike fixed costs. Fixed costs are rarely included in COGS, but variable costs are. Sales fluctuations can affect variable costs if sales commissions are included in per-unit production costs. Even if production drops significantly, fixed costs must be paid.
Bottom Line
Business expenses can be fixed or variable. Variable expenses. Companies pay fixed costs regardless of production. Example: rent. Variable costs—like shipping—change with a company’s production.
