Fixed vs. variable expenses: what's the difference?

Managing a business means keeping a close eye on expenses. Business expenses generally fall into two categories: fixed and variable expenses. Fixed expenses remain constant month after month, while variable expenses can fluctuate based on usage or production.

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Grasping the differences between these types of expenses is essential if you want to get better control over your costs and improve profitability.

What are fixed expenses?

Fixed expenses are monthly business expenses that remain relatively stable regardless of business activity or production levels. These expenses are often contractual or legally binding, so they usually stay the same even if your business scales up or down in the short term.

Examples of fixed expenses

• Rent or lease payments: Payments for office space, warehouses, or storefronts
• Salaries: Fixed monthly wages paid to employees with annual salaries (as opposed to those paid hourly)
• Insurance premiums: Regular payments for small business insurance, health insurance, or liability coverage
• Loan payments: Monthly installments for business loans or mortgage payments with a fixed interest rate
• Subscription fees: The monthly payment for software, services, or membership dues
• Property taxes: Regularly occurring taxes based on the value of owned property
• Straight-line depreciation: The gradual reduction in the value of physical assets over time, such as machinery or vehicles

These expenses create a baseline of financial obligations, so it’s important to ensure your business has enough revenue or cash reserve to cover them even when sales are down.

What are variable expenses?

Variable expenses fluctuate directly in proportion to activity levels and can be higher or lower depending on how much a company produces or sells.

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This variability allows some flexibility in managing costs but also makes these expenses less predictable.

Examples of variable expenses

• Raw materials: Costs for raw materials vary with production volume, like wood for furniture or ingredients for food products
• Utility bills: Electricity, water, and gas expenses can vary based on production activities
• Sales commissions: Payments made to sales staff based on the volume or value of sales they generate
• Shipping and freight: The cost of shipping goods depends on the amount of products sold and transported
• Packaging costs: Expenses related to packaging vary depending on production quantities
• Production supplies: Businesses need more items like tools or chemicals as production increases
• Advertising and marketing costs: Businesses can adjust advertising campaigns or promotion expenses based on marketing strategies or business goals

Understanding variable expenses can help you predict how changes in production or sales will impact their costs. This lets you budget effectively and adjust strategies to improve profitability.

What is the difference between fixed costs and variable costs?

The key difference between fixed and variable costs is their behavior in relation to business activity. Fixed costs remain steady regardless of production levels, while variable expenses change in response to fluctuations in production or sales volume.

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The following table summarizes these differences.

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The role of fixed and variable expenses in business operations

Understanding the difference between fixed and variable expenses provides several advantages.

1. Better budgeting and forecasting: Predictable fixed expenses make it easier to allocate funds, but understanding variable costs helps you refine financial forecasts. This supports more accurate budgeting because you can plan for both predictable expenses and fluctuating costs.
2. Improved cost control: Once you know how to identify fixed and variable expenses, you can develop strategies to prevent overspending during low-revenue periods. Variable costs will naturally fall when sales or production fall, but managing fixed expenses usually involves longer-term decisions, such as negotiating lease agreements or deciding whether to bring on additional salaried team members.
3. More accurate profitability analysis: Understanding fixed and variable costs allows you to calculate your business’s break-even point. Your break-even point is the number of sales units you must hit to generate enough revenue to cover expenses. Calculating this metric can help with decision-making like determining whether to increase the price of your products or services.
4. Enhanced scalability and flexibility: Recognizing the impact of variable expenses helps you make decisions around scaling operations. For example, if you have high fixed costs but low variable expenses, you might struggle to adjust production quickly in response to increased demand. On the other hand, if you have high variable costs, you can adapt more easily to changes in demand.
5. Improved operational efficiency: Analyzing fixed and variable expenses offers insights into where you can improve operations and cash flow. For example, understanding that utility costs fluctuate can prompt energy-saving initiatives, while high fixed costs might indicate a need for renegotiating contracts.

The impact of fixed vs. variable costs on business profitability

Understanding how fixed and variable costs impact profitability is crucial, as these expenses directly affect your business’s profit margins and financial health.

Fixed costs create a consistent baseline of financial obligations you must meet regardless of business activity. If you have high fixed costs, you have high operating leverage, meaning you can significantly increase profitability with additional sales but are at greater risk during revenue downturns. To effectively manage these risks, it's important to understand how to budget for fixed expenses, ensuring that your financial obligations are always met without compromising growth.

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Because variable costs fluctuate with production or sales, they have a more direct impact on profit margins. Higher variable costs reduce your gross margin, affecting the overall profitability of each unit you sell. But since these costs scale with production, they allow more flexibility. You can adjust operations in response to demand without drastically impacting profits.

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By controlling variable costs and optimizing fixed expenses, you can maximize profitability and quickly adapt to changing business conditions.

Let Ramp automate your expense tracking

Accurately tracking your business expenses is the first step to managing fixed and variable costs, and leveraging the right tools can simplify this process. 

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Ramp is a modern expense management platform that streamlines how businesses track and manage their expenses, making financial planning, budgeting, and reporting more accurate and efficient.

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Ramp's automated expense business categorization instantly classifies expenses into fixed and variable, saving valuable time and reducing errors. With real-time data, you can monitor spending against budgets and get insights into spending trends to help you optimize profitability and growth.

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Learn more about Ramp’s automated expense management software to discover how our features align with your business needs.