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

Managing a successful business means keeping a close eye on your expenses. Most common business expenses fall into one of two buckets: fixed and variable expenses.

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At a high level, fixed expenses remain relatively constant month over month, while variable expenses are likely to fluctuate based on usage or production. Identifying and tracking both types of expenses is crucial if you want to get better control over your costs and improve (or chart a path toward) profitability.

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In this post, we’ll define the differences between fixed vs. variable expenses, provide some examples of both, and discuss the financial impact each of these expenses can have on your business.

What are fixed expenses?

Fixed expenses, also known as fixed costs, are business expenses that remain relatively stable from month to month 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

Fixed expenses include monthly expenses like rent, salaries, and loan repayments. Here’s a more detailed breakdown:

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• Rent and lease payments: Payments for office space, warehouses, storefronts, car leases, leased equipment, and so on
• Salaries and payroll expenses: Fixed monthly wages paid to employees with annual salaries, as well as other payroll expenses like costs for employee benefits
• Insurance premiums: Regular payments for small business insurance, workers’ compensation insurance, car insurance, or liability coverage
• Loan and mortgage payments: Monthly installments for loans or mortgage payments with a fixed interest rate, including car payments and small business loan repayments
• Subscription fees: Regular fees for software, services, or membership dues. Depending on your contract, these could be paid monthly, quarterly, or annually
• 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

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These recurring expenses constitute the baseline of your business’s financial obligations, so it’s important to ensure you have enough revenue or cash reserves to cover them, even when sales are slow.

What are variable expenses?

Variable expenses fluctuate in direct proportion to your business activity, increasing and decreasing with your production volume and total sales. This variability creates some flexibility in managing costs, but it also makes these expenses more difficult to budget for.

Examples of variable expenses

Many variable expenses fall into the bucket of cost of goods sold (COGS), including raw materials, utilities, commissions, and other costs that vary based on your level of sales and production:

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• 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 total 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 your production volume
• Advertising and marketing costs: Businesses can adjust their advertising campaigns or promotions based on their business goals

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Understanding variable expenses can help you predict how changes in production or sales will impact total costs. This helps you budget effectively and adjust your strategy as needed to improve profitability.

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What’s 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 importance of understanding fixed and variable expenses

Understanding the difference between fixed and variable expenses gives you better insights into your business spending improves your cash flow management, and protects your bottom line. Here are five reasons why it’s so important to understand the difference between fixed and variable expenses:

1. Better budgeting and forecasting

It’s easy to allocate funds for fixed expenses, but understanding variable costs helps you refine your financial forecasts. This enables more accurate budgeting because you can plan for both predictable monthly payments and the periods when you know you’ll incur higher variable costs based on your business’s past activity over a given period of time.

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 decrease when sales or production fall, but managing fixed expenses usually involves longer-term decisions, such as negotiating contracts 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 point at which you’re no longer operating at a loss—in other words, when your revenue and your expenses are equal. 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 to renegotiate vendor contracts.

The impact of fixed vs. variable costs on profitability

Understanding how fixed and variable costs impact profitability is crucial because they 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 increase profitability with additional sales but are at greater risk during revenue downturns. To effectively manage these risks, it's important to set a monthly budget for fixed expenses, ensuring that you meet your financial obligations 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 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.

Automate your expense tracking with Ramp

Accurately tracking your business expenses is the first step to managing fixed and variable costs, and the right tools make this job a lot simpler.

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That’s where Ramp can help. Ramp is a modern finance operations 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 expense management software automatically categorizes business expenses into fixed or variable costs, saving time and reducing errors. With real-time visibility into all your business expenses, you can track costs against budgets and get insights into spending trends to help you optimize profitability and growth.

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Watch a demo video to learn more about how Ramp customers save an average of 5% a year.