What Is a Fixed Cost? A Simple Definition for Small Businesses
A fixed cost is a cost that doesn’t change much in value regardless of factors like sales revenue or output. Fixed costs tend to be ongoing costs, like insurance, wages, depreciation, rent and interest. Businesses with high fixed costs such as printing operations and manufacturers have higher margins than other companies, according to Business Dictionary.
In this article, we’ll cover:
What Is a Fixed Cost?
A fixed cost is a recurring cost that doesn’t change much in value. Revenue and output level don’t affect fixed costs. Fixed costs include insurance and rent.
All costs do change over time, including fixed costs. That said, fixed costs is a concept used in short-term cost accounting, a method of accounting in which all costs are classified and recorded in the books. The resulting data is analyzed to see where businesses can save.
Small businesses with higher fixed costs are not like those with high variable costs—costs that vary with revenue and output such as raw material and distribution costs. Companies with high fixed costs need to produce more to break even but they also have higher profit margins than companies with high variable costs, according to Business Dictionary.
Companies with high fixed costs also require a different financial structure. They need to produce more and require more resources to do so. To finance these expenses, fixed cost-intensive businesses need the right mix of financing.
Fixed Cost Examples
Fixed costs include:
- Flat-rate utilities
- Recurring business licence and permit fees
Fixed Cost Example #1
A dog grooming company needs to pay rent for its space and pays a flat rate for utilities like cell phone, internet and electricity. The owner employs two dog groomers who are paid hourly. They work the same number of hours every week, so payroll is generally fixed. The owner took out a business loan some years ago to buy equipment and she regularly pays interest on the balance. She is also required by her state to pay for a Pet Grooming Facility License on an annual basis.
Fix Cost Example #2
A freelance SEO (search engine optimization) specialist works from home. Her home office is 20 percent of her apartment, so 20 percent of her rent, renters insurance, water bill and electricity bill are fixed costs for her business. Her water and electricity bills tend to be about the same monthly, so she considers them fixed costs. Her internet and cell phone bills are the same every month. She also pays monthly for a cloud backup solution to backup her files. She took out a line of credit to buy a new laptop six months ago and the interest on that is a fixed cost.
Fixed Cost Example #3
A roofing contractor runs a home-based business. His home office is 10 percent of his house so so 10 percent of his mortgage, home insurance, property taxes, water bill and electricity bill are fixed costs for his company. His van depreciates at a rate of 15 percent per year, which is a fixed cost. He also has to pay for general liability insurance and a contractors licence via his state. He has pays regular wages to one employee.
Fixed Cost Formula
To find total fixed cost, you need to add together all your business’s fixed costs (see above for examples). Then figure out how many products you produce in a month to find average fixed cost. Here’s the formula:
Total Fixed Cost / Number of Units per Month = Average Fixed Cost
For example, a small business has total fixed costs of $1000 a month and they produce 100 products a month. Average fixed cost is $10 per unit.
People also ask:
Is Depreciation a Fixed Cost?
Yes, depreciation is a fixed cost. It is a recurring cost that is typically the same amount every period, according to Accounting Tools. Depreciation isn’t usually affected by output. Buildings and machinery depreciate in value. Land does not depreciate.
Is Advertising a Fixed Cost?
Yes, advertising is a fixed cost. Advertising costs may fluctuate over time, as management may decide to increase and decrease spending over time. That said, advertising isn’t affected by sales or production levels so it is said to be a fixed cost, according to Inc.