What is Fixed Cost?
All business expenses can be divided into two types of costs: fixed and variable. Fixed costs are those expenditures that do not change based on sales (or lack thereof). That is, they are set expenses the business has committed to that are not tied to production volume.
Common fixed business costs include:
- Rent/lease payments or mortgage
- Equipment lease payment
- Car lease payment
- Utility payments
- Phone service
- Business insurance
A Constant Figure
Fixed costs are relatively constant – that is, they don’t change, or vary, much. Your electric bill, for example, might increase a little during warmer months due to increased air conditioning usage, or your phone bill might rise a tad if you suddenly win an international client, but month-to-month, there should be little change.
Calculating Total Fixed Costs
To determine an organization’s total fixed costs, simply add all of the various fixed costs together. Total fixed costs are the sum of all individual fixed costs.
Impact on Profitability
Some types of businesses have high fixed costs, perhaps because of large equipment costs or space requirements, such as a commercial printing operation. The cost to acquire the machinery and the space is high so, therefore, monthly payments are high no matter how many printing jobs the business has. However, once those fixed costs are recouped and the company reaches its break-even point, the costs associated with production are generally quite low. Meaning, once a high-fixed-cost business hits its break-even point, it is fairly easy to generate profits from then on, since its variable costs – the expenses associated with product manufacturing – are lower.
And at the other end of the cost spectrum, companies with relatively low fixed costs, such as graphic designers or merchandising consultants, then have higher variable costs. It doesn’t take much revenue for such service businesses to break-even, generally, but the amount of profit generated after that point remains about the same. Profits don’t skyrocket after all the fixed costs are covered like they do with the high-fixed-cost ventures.
In general, keeping fixed costs low is a smart financial strategy.