Fixed costs vs variable costs: Why businesses need to distinguish clearly

If you have just started a business or are analyzing where your money is going, you must understand Fixed Costs (Fixed Cost) and Variable Costs (Variable Cost), as these two types behave very differently. Proper management depends on correctly categorizing them.

What are Fixed Costs? Simple Explanation

Fixed Costs (Fixed Cost) are expenses that must be paid regardless of whether the business sells anything or not. Whether this year you sell a lot or a little, the amount remains the same. Sometimes called “necessary costs” because there’s no way to escape them.

For example, if you rent an office for 10,000 baht per month, whether you sell millions this month or none at all, the rent bill still comes to 10,000 baht.

Common examples of fixed costs:

• Office rent - unchanged every month
• Salaries of permanent staff - fixed wages regardless of performance
• Business and equipment insurance - paid regularly to mitigate risks
• Depreciation of buildings and machinery - calculated consistently annually
• Loan interest - if borrowing from financial institutions, interest must be paid continuously

Why are Fixed Costs Important?

Because they act as a “baseline” indicating how much the business must sell at minimum to avoid losses. If fixed costs are high, you need to plan your finances carefully and set revenue goals high enough to cover them.

What are Variable Costs? How are they different from fixed costs?

Variable Costs (Variable Cost) are costs that change according to the volume of production or sales. The more you sell, the higher these costs become; if you sell less, they decrease accordingly.

For example, if you make leather bags, each bag requires leather and labor. If you take an order for 10 bags, you use 10 units of leather; if you take 100 bags, you use 100 units. Costs change based on order quantity.

Common examples of variable costs:

• Raw materials and components - such as leather, rubber, steel, which increase with the amount of goods
• Direct labor wages - wages paid to workers producing the goods, often paid per piece or output
• Packaging and wrapping costs - materials used to package products, increasing with sales
• Shipping and delivery costs - higher sales mean higher shipping expenses
• Sales commissions - payments to sales staff based on sales volume

Why are Variable Costs More Flexible?

Because you can control them by adjusting production or sales volume. If the market shrinks, reduce production, and costs decrease accordingly. If the market improves, increase production, and costs will rise but so will revenue proportionally.

How to clearly distinguish and utilize these costs

To manage your costs effectively, consider the following steps:

Step 1: Identify and categorize costs

Sit down and list all business expenses, then ask yourself: “Does this cost change with sales volume?”

• If no → it’s a fixed cost
• If yes → it’s a variable cost

Step 2: Calculate the Break-Even Point (Break-Even Point)

This is the minimum quantity or sales amount you need to reach to avoid losses. The simple formula is:

Break-Even Point = Total Fixed Costs ÷ (Selling Price per Unit - Variable Cost per Unit)

For example, if total fixed costs are 100,000 baht, selling price per unit is 500 baht, and variable cost per unit is 200 baht, you need to sell at least 334 units to break even.

Step 3: Use this information to make decisions

• Pricing: Ensure the selling price covers both fixed and variable costs, leaving a profit
• Production planning: Knowing the break-even point helps determine how much to produce or sell to keep the business afloat
• Investment decisions: When considering buying new machinery or opening a new branch, calculate how fixed costs will increase and how revenue should grow accordingly

Main differences between Fixed Cost and Variable Cost

Techniques to control and reduce costs

For Fixed Costs

Fixed costs are hard to reduce because they are set; however, you can:

• Reduce their level - move to smaller or cheaper office spaces
• Share risks - co-rent space with others to lower rent per person
• Increase efficiency - cut down on unproductive staff or implement automation

For Variable Costs

Variable costs are easier to control:

• Negotiate with suppliers - ask for better prices for bulk purchases
• Improve production processes - reduce time or raw material waste
• Choose reliable suppliers - some may offer lower prices without sacrificing quality

Summary: Why is this distinction crucial for your business?

Understanding Fixed Costs and Variable Costs is not just theoretical; it directly impacts real business decisions:

• Pricing: Set prices to cover fixed costs; otherwise, even high sales won’t prevent losses
• Business expansion: Know how much fixed costs will increase before opening new branches
• Setting benchmarks: Calculate your break-even point; running blindly leads to failure
• Competition: Companies that control costs well tend to be more competitive

Good cost management is the core of sustainable business, enabling you to grow appropriately and remain resilient when market conditions change or competition intensifies.