Fixed Costs Definition
Learn more about what fixed costs are in business.
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Business planning is a major step in starting a business. You’ll need to know how much your business can spend on rent, utilities, and other overhead costs. If you’re looking for a fixed costs definition, look no further. Our business experts will guide you through everything you need to know about the meaning of fixed costs.
What are fixed costs?
Entrepreneurs need to consider the fixed costs when planning and budgeting. Fixed costs are the costs that remain the same during a period of time, regardless of production amounts. The business must pay its fixed costs to stay in business.
What is the importance of fixed costs?
Fixed costs are one factor used to determine your total cost of production and break-even point.
Cost of Production
In business, your cost of production is a combination of fixed costs and variable costs. If you know your total cost of production and variable cost per unit, calculate your fixed costs as:
Fixed Cost = Total Cost of Production – (Number of Units Produced * Variable Cost Per Unit).
In comparison to fixed costs, which stay the same throughout an accounting period, variable costs are dependent on production levels. With each unit produced or service provided, the variable costs increase. Fixed costs, however, remain constant depending on their contract terms (such as a rental lease).
Break-Even Point
When investors consider your company, they will want to know your expected break-even point. The break-even point represents the amount of money your business needs to cover its expenses. At the break-even point, there are no losses or profits. To determine how many sales you need to make to break even, use this formula:
Break-Even Point in Units = Fixed Costs ÷ (Price – Variable Costs).
Fixed Costs Benefits
The fixed costs advantages include:
- They remain constant throughout a given period.
- They’re easy to account for, as they’re known beforehand.
- They have a low impact in case of increased levels of production.
Because fixed costs don’t change, your average cost per unit will decrease if you increase your output without adding other fixed costs.
Fixed Costs Considerations
Fixed costs have some disadvantages, including:
- Fixed costs can raise the cost of doing business. Their impact on the break-even point can be significant.
- Changes in norms, policies, schedules, or agreements may cause fixed costs to change.
- When sales decline, the profit of businesses with high fixed costs suffers.
- Fixed costs impact business profitability, and an increase in fixed costs in the future can result in lower profits.
Regardless of your business or industry, it’s important to account for your fixed costs. Because fixed costs don’t directly impact your production, consider your business needs when electing new fixed costs.
Fixed Costs Examples
The definition of fixed costs includes start-up costs, one-time fees, and costs required to keep the business compliant. Examples of fixed costs include:
- Rental lease payments
- Salaries
- Property taxes
- Insurance
- Interest
- Depreciation
- Lawyer and accountant
- Office space
- Equipment and supplies
- Utilities
- Licenses and permits
- Inventory
- Advertising and marketing
Sometimes business calculations include another cost called the “semi-variable.” Semi-variable costs can change with increased or decreased production levels, but you can predict them like fixed costs. For example, you may need to increase your costs for salaries because you need more employees to increase production.
Summary
Business owners use the fixed costs definition when budgeting and planning for a small business. Fixed costs must be paid to keep the business running and don’t change with the number of sales.
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Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
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