Costs are an indispensable part of your business. While some costs are fixed, some are variable. As a business owner, understanding the difference between fixed and variable costs is important as it affects your profits.
We share some fixed and variable cost examples for different industries to help you understand them better.
The total cost of running your business can be divided into two major categories - fixed and variable costs. While fixed costs are not related to the production volumes, variable costs are related directly to them.
Apart from fixed and variable costs, there is a third category of costs for every business known as semi-variable costs. This is a combination of both fixed and variable costs. Let's find out more about each category.
Fixed costs or overheads are those which remain the same regardless of a change in your production volumes. In other words, they remain the same every month.
An example will clarify the concept. David Lee is the owner of a graphic design startup. He has hired a small apartment for his work. Whether David serves ten customers or 100, the rent he pays for the apartment remains the same.
If David was operating out of a property he owns, he would have to pay property taxes instead of rent. He would have to pay it regardless of whether his business was doing well or not. You can find fixed costs in your income statement and balance sheet.
What are variable expenses? Costs that are directly associated with the production and sale of goods are known as variable expenses. The raw materials and labor that go into producing goods are variable costs and are collectively known as the cost of goods sold.
The higher the goods produced and sold, the higher will be the variable expenses. If you own a pizza shop, you will need more raw materials for making pizzas with higher sales. As you produce more pizzas, you pay more for the raw materials.
Since variable costs fluctuate with production, it's easier to control them compared to fixed costs. You could switch to a raw material supplier who gives you a better deal. This would directly boost your revenues.
There are certain costs that remain fixed up to a certain level of production, but you need to pay more when you cross that level.
Payment for overtime is a great example of semi-variable costs. If you are producing 100 pizzas during the weekday, and that goes up to 200 pizzas a day during the weekend, your staff will need to work overtime, for which you will have to pay them extra.
Another example of semi-variable costs would be electricity. The number of appliances and the hours they are used for determines your electricity bill. If your staff is working overtime, it would mean that electricity consumption would be higher, and you would pay a higher bill than usual.
The comparative chart below would make it easier to understand the difference between fixed, variable, and semi-variable costs.
Good question! When it comes to fixed and variable costs, it depends on the specific requirements of your industry and company. These expenses are essential for running your business, even though they reduce the net profit you make as a business owner.
Both expenses are a part of every business, and neither can be called better or worse. The good news is that when you study your income statement, you get details of both costs. You could introduce automation in production and bring down your variable costs to increase your gross profit.
Lower administrative expenses or fixed costs increase the net profit. When you focus on both, your profits go up. Let's check out examples for fixed and variable costs for different industries for greater clarity.
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The major part of your total costs in the manufacturing industry includes raw material, labor, and equipment maintenance expenses.
The fixed costs for manufacturing include equipment depreciation, indirect expenses like supervisor wages, renewal of business license, and insurance premiums.
The variable costs for manufacturing include labor, raw materials, freight charges (both incoming and outgoing), and credit card fees.
Examples of semi-variable costs in manufacturing include utilities (since they vary according to your consumption of water and electricity), bookkeeping charges (could increase if the volume of transactions or services goes up), and equipment maintenance expenses (would depend beyond a certain volume of production).
The primary costs that apply to the restaurant industry include loan payments and depreciation of equipment. If you have taken a loan to start your restaurant, loan repayments would be a major cost. Since the equipment in a restaurant undergoes high wear and tear, depreciation is another factor to account for.
Examples of fixed costs for the restaurant industry include rent, loan payments, insurance premiums, salaries, license fees, and mortgages.
Variable costs for restaurants include utilities, raw materials and beverages, and marketing.
Semi-variable costs comprise hourly wages, water, and electricity. Hourly wages are calculated based on the hours worked. Charges for water and electricity can go up if operations are increased.
The costs that are mainly a part of a home-based e-commerce company include web hosting, marketing, shipping, and handling.
The fixed costs for the e-commerce industry include rent, web hosting, internet charges, utilities, and subscriptions to third-party platforms like Shopify. Like any other business, the rent remains the same regardless of the volume of business.
You must choose an internet plan according to your business' needs, and the charges for this plan remain fixed. Shopify is an e-commerce platform that helps you sell your products, and they have partner programs for sellers. The charges for utilities remain constant since they are not affected by business volumes.
Examples of variable costs include payments to graphic designers, social media marketers, advertising, supplier payments, and shipping charges. For an e-commerce business, you need to advertise on social media, and your costs depend on which stage your business is at. Shipping and handling charges depend on the destination.
Semi-variable expenses include an email marketing platform where you need to pay a fee and additional charges depending on your contacts and emails. Order fulfillment is another example where a platform provides end-to-end logistics services.
Understanding the difference between fixed and variable costs is key to keeping your business' finances in check, especially if you're a small enterprise. One way to go about this is to outsource your bookkeeping needs to an industry leader like Fincent to ensure that your finances and records are always accurately recorded, allowing you to focus on scaling your business.
Fincent: Your Business's Personal Financial Wizard - From Bookkeeping to Tax Filing