What are business fixed costs?
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As a small business owner, understanding your total fixed costs is critical to keeping your business profitable.
In this article, we'll define fixed costs, list some common fixed expenses for small businesses, and offer some advice on how to manage your fixed costs effectively.
What is a fixed cost?
A fixed cost is a business expense that remains constant regardless of your business activity or sales, such as rent, salaries, and insurance premiums. Whether you're selling one product or one thousand products, your sales volume will not influence your fixed costs.
These costs are usually vital to the operations of your business, so they must be paid even when sales are low. Your fixed costs can provide a clear basis for budgeting and financial planning, helping you predict profitability and conduct a break-even analysis.
Examples of fixed costs
Some examples of fixed costs include rent or mortgage payments, insurance, equipment leases, and some utilities. Here’s a list of common fixed costs in more detail:
- Rent or mortgage payments. Monthly rent and mortgage payments are considered fixed expenses for small businesses, though they can change with lease renewals, refinancing, and if your debt is sold to another entity.
- Property taxes: Property taxes are a fixed expense incurred by entrepreneurs, usually paid on an annual or semi-annual basis.
- Insurance. Insurance policies covering property, workers’ compensation, and liability are another common fixed expense for small business owners.
- Salaries and wages. The salaries of your employees are also fixed costs. Even if you don't have many employees, their monthly wages will remain the same for their contract.
- Equipment leases or payments. You'll have a fixed fee if you lease any equipment for your business, such as computers, printers, or vehicles.
- Loan payments. If you have a small business loan, your monthly loan payments can remain the same until the loan is paid in full.
- Utilities. Electricity, water, and some other utilities also fall under fixed costs. While they may fluctuate with usage, these expenses are necessary for most businesses. Some companies offer fixed-rate packages that help keep your utility bills consistent each month.
- Depreciation. Depreciation is the gradual reduction in the value of physical assets like machinery or buildings over a period of time, which is accounted for as a fixed cost on income statements.
Fixed costs vs. variable costs
There are two types of costs: Fixed and variable. Fixed costs remain constant regardless of production levels, while variable costs fluctuate in direct proportion to your production volume or sales. So, as your level of production increases, your total variable costs increase.
Common examples of variable costs include:
- Shipping and delivery costs
- Raw materials
- Processing fees
- Taxes and tariffs
Since variable costs are less predictable, they can make budgeting and financial forecasting more difficult. Their month-to-month fluctuations can cut into your profit margins, especially during periods when they spike significantly.
How to calculate fixed costs
To calculate your fixed expenses, you'll need to know your total costs of production and variable costs per unit.
Once you have that information, you can use the following formula to calculate your fixed costs:
Fixed Cost = Total Costs of Production - (Variable Cost Per Unit * No. of Units Produced)
For example, let's say your business manufactures widgets. The total cost of producing 1,000 widgets is $10,000. The variable cost per widget is $0.50. To calculate your fixed costs, you can use the following formula:
$9,500 = $10,000 - ($0.50 * 1,000)
Therefore, the fixed cost to produce 1,000 widgets is $9,500.
It's important to note that fixed costs can change over time. For example, if you sign a new lease for your office space, your rent payments may go up or down. The key is to track your fixed costs regularly so you can budget accordingly.
The bottom line
Understanding fixed costs is crucial for small business owners as it forms the basis for effective financial planning and strategic decision-making.
A clear grasp of your fixed costs allows for precise budgeting, lets you calculate your break-even point, and provides a level of financial predictability amid the variable nature of other expenses.
By managing fixed costs proactively, you can better navigate financial uncertainties, optimize profitability, and position your business for long-term success.
Manage your business expenses with Ramp
If you're looking for a better way to handle your operating expenses, Ramp is here to help. Our spend management software makes it easy to track and manage your business expenses in one place.
Financial planning and analysis are Ramp's core features—we built our software to help small businesses do just that.
Learn more about how Ramp can help your business save.