Fixed costs and variable costs are two types of expenses that businesses incur, but they differ in their characteristics and behavior:
Fixed Costs:
- Fixed costs are expenses that remain constant regardless of changes in production levels or sales volume.
- Examples of fixed costs include rent, salaries of permanent staff, insurance premiums, depreciation on fixed assets, property taxes, and utilities (to some extent).
- Fixed costs are incurred even if production stops or sales decline.
- The total amount of fixed costs remains unchanged within a certain range of activity.
- However, on a per-unit basis, fixed costs decrease as production or sales volume increases because the same fixed costs are spread over a larger number of units.
Variable Costs:
- Variable costs are expenses that fluctuate in direct proportion to changes in production levels or sales volume.
- Examples of variable costs include raw materials, direct labor, packaging, sales commissions, shipping costs, and utilities (that vary with production).
- Variable costs increase as production or sales volume increases and decrease as production or sales volume decreases.
- The total amount of variable costs varies proportionally with activity levels.
- On a per-unit basis, variable costs remain constant regardless of the level of production or sales.
In summary, the key differences between fixed and variable costs lie in their behavior in response to changes in activity levels and their impact on per-unit costs. Fixed costs remain constant regardless of activity levels, while variable costs fluctuate with changes in production or sales volume. Understanding these differences is crucial for businesses to accurately assess their cost structure, plan budgets, set prices, and make strategic decisions regarding production levels and operational efficiency.