What is fixed cost and how to determine fixed costs in a business

Cost management is at the heart of any business, especially the classification of fixed costs and variable costs, which helps managers make informed decisions regarding investment, pricing, and growth planning. This article will explain what fixed costs are and how to determine a business’s fixed costs for financial analysis.

Fixed Cost (Fixed Cost) refers to expenses that do not depend on production levels

Fixed Cost (Fixed Cost) refers to business expenses that remain the same regardless of changes in production or sales volume. Even if the business temporarily halts production or reduces sales, these costs must still be paid. They are ongoing financial obligations throughout operations.

Key characteristics of fixed costs

Fixed costs are important in financial planning because they are stable. Businesses can forecast in advance how much they need to pay, unlike variable costs that depend on daily operations.

Knowing and analyzing fixed costs accurately will help businesses:

• Calculate the break-even point correctly
• Set prices that cover basic costs
• Estimate the sales volume needed to generate profit
• Assess financial risks

Examples of fixed costs commonly found in businesses

Rent for premises and buildings

Rent for factories, offices, or shops is a fixed cost paid monthly, regardless of the level of production or service output.

Employee salaries

Regular salaries paid to full-time employees or freelancers under contractual agreements are fixed costs that do not change.

Business insurance

Expenses for building, product, or liability insurance, paid according to insurance contracts over a specified period.

Asset depreciation

Depreciation of equipment, machinery, or buildings used in business operations is a fixed accounting expense calculated annually.

Loan interest

Interest payable on loans from financial institutions remains fixed according to the initial loan agreement.

Utility costs such as electricity, water, or other public services

Some of these expenses may be fixed costs paid regularly each month, even though they may also have variable components.

Variable Cost (Variable Cost) changes with production volume

Variable costs are expenses that increase as production increases and decrease as production decreases. These costs are directly related to the level of operations.

Examples of variable costs

• Raw materials and production supplies: The more products produced, the more raw materials need to be purchased.
• Direct labor wages: Wages paid to production staff based on the number of units produced.
• Packaging costs: Expenses for wrapping materials that increase with the number of products.
• Transportation and shipping costs: Expenses for delivering goods that increase with order volume.
• Sales commissions: Payments based on sales performance.
• Energy costs: The portion of electricity costs that increase with production activities.

Differences between fixed costs and variable costs

How to determine a business’s fixed costs

1. Review contracts and payment agreements

List expenses with fixed contracts or agreements, such as lease contracts, employment contracts, or loan agreements.

2. Analyze monthly budgets

Review payments recorded in bank statements or accounting systems month by month. Recurring monthly expenses are often fixed costs.

3. Differentiate from variable costs

For expenses that are unclear, check whether they are related to production or sales volume. If not, consider them fixed costs.

4. Use formulas for analysis

Total Cost = Fixed Cost + (Variable Cost per Unit × Number of Units)

By summing all expenses that do not change, you can determine the fixed costs of the business.

Using fixed costs in business decision-making

Pricing

Ensure that the selling price is high enough to cover both fixed and variable costs and generate profit.

Production planning

Knowing fixed costs helps managers understand how many units need to be sold to cover basic expenses.

Investment evaluation

Deciding whether to invest in new machinery involves considering how much fixed costs will increase and how much variable costs can be reduced.

Break-even point calculation

Formula: Break-even point = Fixed Costs ÷ (Price per unit - Variable Cost per unit)

This formula indicates how many units need to be sold to avoid losses.

Summary

Understanding and accurately identifying a business’s fixed costs are fundamental to effective financial management. Knowledge of different cost types enables managers to make systematic decisions regarding investment, pricing, and growth planning.

In-depth analysis of fixed costs not only helps control expenses but also enhances competitiveness and financial stability in the long term.