Quick Summary
Fixed costs remain constant regardless of output, while variable costs fluctuate with production levels. Understanding both is crucial for budgeting, pricing, and profitability.
The difference between fixed cost and variable cost lies in their behavior—fixed costs stay the same (e.g., rent), while variable costs change based on activity (e.g., raw materials).
Real-world examples of fixed-cost and variable-cost comparisons include rent and salaries (fixed) vs. packaging and labor (variable) in sectors like retail, manufacturing, tech, and food delivery.
These cost types influence break-even analysis, pricing strategy, and profit planning. High fixed costs require high-volume sales, while high variable costs affect margins.
Effective cost management involves controlling fixed costs and optimizing variable expenses. Startups, businesses, and students benefit from understanding what is fixed cost and variable cost for smarter decision-making.
Managing costs effectively is essential to profitability and long-term sustainability in business and economics. Among the many types of expenses, a business incurs, fixed cost and variable cost stand out as fundamental concepts every entrepreneur, student, and manager must understand.
But what is fixed cost and variable cost? How do they affect budgeting, pricing, and decision-making? Why is it important to know the difference between fixed cost and variable cost?
In this comprehensive guide, we’ll explain the concept, explore the fixed-cost and variable-cost examples, and discuss how these costs play a crucial role in financial planning.
Fixed Cost Definition: A business’s total cost includes fixed and variable costs. Fixed costs are expenses that do not change with a change in the number of goods and services produced. Due to this nature, fixed costs are also known as indirect costs. They don’t change over time and are often agreed upon in contracts.
This example explains the fixed cost. Suppose a company, XYZ, spends INR 50,000 monthly to rent a machine to produce plates. Even if the company does not produce any plates, it would still have to pay the rent for the machine.
Examples of fixed costs include:
Fixed costs are related to recurring costs, which may not always be directly related to the production process. Some fixed-cost examples are rent, insurance, interest payments, salaries, and taxes. Companies decide their shutdown point based on their fixed costs.
Variable cost Definition: Variable costs change with a change in the company’s production. A direct relationship exists between variable costs and the number of goods produced. As the production volume increases, variable costs also increase. Variable cost is also known as short-term cost. It can be adjusted quickly. If a company has cash flow issues, it can try to cut down on variable expenses. Raw materials, commissions, utility expenses, and packaging costs are examples of variable costs.
Raw materials are the goods that are processed and turned into the final goods. They include coal, wood, oil, etcetera. Commissions are the percentage of sales proceeds given to a salesperson. Utility expenses include electricity and water bills, which differ from endeavor to endeavor. Also, the costs of packaging and shipping goods remain variable.
Examples of variable costs include:
Understanding fixed cost and variable cost is key to building a resilient business model. It helps determine the break-even point, forecast profits, and evaluate performance.
The following are the differences between fixed cost and variable cost:
The difference between fixed cost and variable cost becomes clearer when we look at specific real-life examples.
Fixed and variable costs both impact a business’s gross and operating profits. The higher the costs, the lower the gross and net profit. Without a healthy profit, an all-encompassing bottom line is also not possible. Companies, therefore, work to reduce costs to increase profits. Since fixed costs cannot always be controlled, it is especially important to manage variable costs.
The break-even analysis helps you manage the size of the units to be sold. It also helps set targets and budget. When companies know at what point they will break even, they can easily set up their budgets and goals according to that point. This analysis helps the company have realistic targets. The break-even analysis also plays an essential role in developing safety reports. Companies’ sales fall during financial breakdowns. In such a situation, this analysis helps the company calculate the minimum number of sales needed to make a profit, enabling better business decisions.
Most importantly, the break-even point analysis can help design a pricing strategy. Businesses can determine the minimum prices to cover costs by calculating the break-even point. This point can be measured against the market price to help improve the business’s pricing strategy and determine if the selling prices should be changed.
Knowing how fixed cost and variable cost behave under changing circumstances helps evaluate profitability.
This dynamic also impacts pricing strategies. Businesses with high fixed costs often pursue aggressive sales volumes, while businesses with high variable costs may focus on margin.
These measures help maintain financial health and improve profit margins by balancing fixed cost and variable cost intelligently.
Startups often struggle with managing cash flow, making cost analysis even more critical. A startup with low fixed costs has more flexibility and can pivot easily. On the other hand, a startup with high fixed costs may find it harder to adapt to market changes and generate revenue for the company.
Understanding what is fixed cost and variable cost enables startups to plan lean operations, allocate resources wisely, and survive longer in competitive markets.
Let’s clear up some misunderstandings:
Understanding what is fixed cost and variable cost properly helps avoid these common pitfalls in planning and analysis.
Also Read: Net Profit: Understanding Its Significance for Your Business
Mastering the concept of fixed cost and variable cost isn’t just for accountants—it’s for anyone who wants to make smarter financial decisions. Whether you’re managing a company, running a side hustle, or studying for your MBA, understanding what is fixed cost and variable cost and how they impact your bottom line is invaluable.
Recognizing the difference between fixed cost and variable cost, supported by relevant fixed cost and variable cost examples, allows you to build a more efficient, resilient, and profitable operation.
In a business environment filled with uncertainties, costs are one of the few elements you can analyze, plan, and control. The first step in that journey is knowing the basics of fixed costs and variable costs.
Fixed costs are expenses that don’t change with production levels, like rent or salaries, regardless of output. Variable costs, on the other hand, fluctuate with production, such as raw materials or labor costs. For example, a factory’s rent is fixed, while costs for raw materials are variable.
A fixed cost, like rent or insurance, remains constant regardless of production. A variable expense, however, changes based on production or sales volume, such as raw materials or commissions. Fixed costs are predictable, while variable expenses fluctuate with business activity.
TFC (Total Fixed Cost) remains constant regardless of output, like rent or salaries, and doesn’t change with production. TVC (Total Variable Cost), on the other hand, changes with production levels, such as costs for raw materials or hourly wages. TFC is constant, while TVC fluctuates.
A variable cost changes with production volume. For example, in a factory, the cost of raw materials like steel or fabric increases as more products are made. Similarly, labor costs can rise if more workers are hired based on the output required for a given period.
Salaries are typically considered fixed costs because they remain constant regardless of production levels. However, if a salary is tied to performance or production, like commission-based pay, it can become a variable cost. Generally, base salaries are fixed, while commissions vary.
Fixed overhead refers to costs that do not change with production levels, such as rent, salaries, and insurance, remaining constant regardless of output. Conversely, variable overhead fluctuates with production levels, including expenses like utilities and raw materials, which increase as production rises and decrease when production slows.
Fixed cost is a business expense that remains constant regardless of production or sales levels. It includes costs like rent, salaries, insurance, and depreciation, which do not fluctuate with changes in output.
The variable cost formula is:
Variable Cost = Cost per Unit × Total Number of Units Produced
This formula calculates expenses that change with production levels, such as raw materials and direct labor, increasing as production rises and decreasing when it falls.
Authored by, Amay Mathur | Senior Editor
Amay Mathur is a business news reporter at Chegg.com. He previously worked for PCMag, Business Insider, The Messenger, and ZDNET as a reporter and copyeditor. His areas of coverage encompass tech, business, strategy, finance, and even space. He is a Columbia University graduate.
Editor's Recommendations
Chegg India does not ask for money to offer any opportunity with the company. We request you to be vigilant before sharing your personal and financial information with any third party. Beware of fraudulent activities claiming affiliation with our company and promising monetary rewards or benefits. Chegg India shall not be responsible for any losses resulting from such activities.
Chegg India does not ask for money to offer any opportunity with the company. We request you to be vigilant before sharing your personal and financial information with any third party. Beware of fraudulent activities claiming affiliation with our company and promising monetary rewards or benefits. Chegg India shall not be responsible for any losses resulting from such activities.
