Important to know: How do fixed costs and variable costs differ, and how do they affect your business?

As a business owner or executive, classifying costs is not just a matter of general accounting but a crucial gateway to making sound financial decisions. Differentiating between fixed and variable costs, along with understanding the hidden fixed production expenses in operations, will help you plan finances, set pricing strategies, and develop growth plans more reasonably.

Starting with the basics: What is (Fixed Cost)

Simply put, Fixed Cost (Fixed Cost) refers to expenses that a business must pay regardless of sales volume. Whether you sell more or less, whether you produce at half capacity or full capacity, these costs remain there, waiting for you to pay.

This is why businesses need to understand fixed production expenses—they are a significant burden that management must handle systematically. For example, factory rent remains the same whether you produce 100 or 1,000 units. Fixed costs have two key characteristics:

Do not change with production volume – Whether you increase or decrease production, fixed costs stay the same.

Are long-term decisions – Fixed costs relate to long-term contracts or commitments, such as lease agreements or employment contracts, which are not easily altered.

What are fixed costs: Items you pay every month

Business owners should prepare for these fixed costs:

Rent – Whether you are renovating processes or expanding production, rent remains unchanged.

Employee salaries – Salaries for permanent staff or fixed production-related personnel must be paid regularly, regardless of sales or production volume.

Various insurances – Business insurance, asset insurance, liability insurance, etc., are predictable and fixed expenses.

Depreciation of equipment – Machinery and equipment purchased at the start of the business will depreciate at a fixed rate annually.

Loan interest – If you borrow funds for investment, the annual interest will be a fixed amount.

Managing these fixed production costs efficiently is considered a core skill of management because it determines how much the business needs to sell to break even.

Now, let’s look at the other side: What is (Variable Cost)

Contrary to fixed costs, (Variable Cost) are expenses that “dance to the rhythm” of production. As you produce more, variable costs increase; as you produce less, they decrease proportionally.

Main characteristics of variable costs:

Change with production – These are more flexible costs, allowing managers easier control.

Lower risk – You can reduce variable costs when production volume drops, unlike fixed costs which are inherent.

What are variable costs: Costs that increase with production

Examples of variable costs that business owners encounter:

Raw materials and components – The more you produce, the more raw materials you need to purchase.

Direct labor wages – Increased production may require hiring additional staff or paying overtime, raising wages.

Energy costs – Machinery consumes more electricity as production increases, affecting electricity and water bills.

Packaging and shipping costs – Selling more means more packaging and shipping, increasing these costs proportionally.

Commissions – If your sales team earns commissions based on sales volume, this cost varies with sales.

Because variable costs are flexible, managers can find ways to reduce these costs, such as negotiating with suppliers or improving production processes.

The difference between the two: Why does it matter?

Understanding the difference between fixed and variable costs determines three key aspects:

Break-even point planning – High fixed costs mean you need to sell a large volume to break even, while high variable costs may result in a lower break-even point but lower profit per unit.

Risk – Businesses with high fixed costs face greater risk because they must pay these costs regardless of revenue. Those with high variable costs are more flexible.

Investment strategies – Companies with high fixed costs (such as factories) might decide to invest in automation to reduce future variable costs (like labor).

How to improve your cost structure

Analyzing fixed production costs is the first step. Here are ways to improve:

Reduce fixed costs – Negotiate with property owners to lower rent or consider partial remote work.

Enhance variable cost efficiency – Negotiate with suppliers for bulk purchasing discounts.

Balance costs – Sometimes investing in fixed costs (like machinery) can reduce variable costs such as labor over time.

Summary: Why is this important for your business

Understanding fixed and variable costs, along with managing fixed production expenses, is not just accounting—it’s the art of business management. It helps you:

• Set competitive prices while maintaining profit margins
• Plan production and resource allocation wisely
• Forecast break-even points and sales targets
• Identify opportunities to reduce costs
• Make informed decisions about new investments

Managers who grasp these concepts have a competitive edge and can build long-term financial stability for their business.