Fixed and variable costs: what are they, what are they, differences and examples

Fixed and variable costs are the outlays of money that a company has to make to guarantee its operation.

The difference between fixed and variable costs is that fixed costs are generated on a regular basis and do not depend on the levels of production or profit of the company. While variable costs are only generated based on the levels of production of the company.

For example, a company that operates in a rented premises will always have to pay rent (fixed cost), but will only have to pay for extra raw material if production increases (variable cost).

Fixed costs	Variable costs
Definition	They are the payments that must be made regularly so that the company can function.	They are the payments that must be made eventually if there is an increase in production
Frequency	Regular (weekly, monthly, bi-monthly, etc.)	Irregular (only paid when generated).
Types	Committed. Discretionary.	Progressive. Regressive. Proportional.
They depend on the production	Not always.	Yes.
They are programmable	Yes.	Sometimes.
Examples	Payments to employees. Service payments (water, electricity). Taxes.	Extra hours. Packaging. Raw material.

What are fixed costs?

They are all the costs that a company is going to generate on a regular basis, regardless of its production or profit levels. This means that they will be generated regardless of the financial status of the company.

As the name implies, the fixed costs are going to be permanent as long as the business is in operation. For this reason, it is vital to have financial resources that can cover them in case the main sources of income decline.

An example of a fixed cost is the rental of a business premises. If the payment of the rent depends directly on the sales of the business, at the moment in which the sales decrease, the payment can be compromised, and with it, the operation of the company.

What are the fixed costs?

Fixed costs are classified into two categories, based on their ability to modify:

Committed
They are fixed costs that cannot be altered, because doing so can affect the operation of the company. An example would be taxes, since it is required to pay the amount that the tax entity has, otherwise the company may be sanctioned.

Discretionary
They are fixed costs that can be altered if needed, without this having an impact on the operation of the company. For example, the budget for advertising. If that cost decreases, production is not affected.

Examples of fixed costs

• Rentals: premises, automobiles, furniture, machinery, etc.
• Payroll: of labor and administrative personnel.
• Taxes: local, national taxes, etc.
• Licensing: operating systems, accounting, cloud services, etc.
• Services: water, electricity, internet, etc.
• Insurance: against fire, against theft, etc.
• Supplies: office supplies, cleaning products, etc.

See also: Difference between cost and expense

What are variable costs?

They are costs that originate or that vary depending on the levels of production of a company. Therefore, they are not fixed, since they depend on the operation of the company.

The more production there is, the more variable costs will be generated. And if production decreases, variable costs will also decrease.

Although these types of costs are not foreseen as part of the regular operations of the company (since they are variable), they can be programmed or controlled by the organization.

For example, a company that produces chocolates knows that on Valentine's week it sells 120% more boxes of chocolates than a month of regular sales, so it prepares with anticipation to assume the variable costs implied by the increase in production: more raw material, payment of temporary labor or overtime pay, more boxes for the products, etc.

What are the variable costs?

Variable costs are classified into three types, depending on the increase or decrease in production:

Progressive

They are all variable costs that increase if production is increased. For example, buying more raw materials in an exceptional production season, such as a toy factory preparing for Christmas sales.

Regressives

They are variable costs that decrease with increasing production. For example, the more products are manufactured, the lower the shipping cost.

Proportional

They are costs that are generated according to the quantity produced. For example, a company that produces a thousand extra products will need to buy a thousand more packages.

Examples of variable costs

• Commissions for sales: the more products sold, the higher commissions for employees.
• Workforce: the less production, the less labor is needed. And the higher the production, the higher the workforce.
• Packaging: the more production is generated, the more packaging supplies (bags, boxes, envelopes, etc.) will be required.
• Raw material: if production increases, you have to buy more raw materials. And if production decreases, you have to buy less.

See also:

• Difference between assets, liabilities and equity
• Difference between simple and compound interest
• Difference between salary and salary