What are fixed costs? Definition, examples, and how to calculate them

Managing fixed costs effectively can make or break your business's profitability. These unavoidable expenses form the basis of your financial model and directly influence your bottom line.

Whether you're a startup founder or seasoned entrepreneur, getting a solid grasp on your business's fixed costs helps you make smarter budgeting decisions, price your products correctly, plan for growth effectively, and build a more sustainable business foundation.

In this guide, we’ll cover the essentials of fixed costs, from what they are to why they matter, and how to calculate them.

What is a fixed cost?

Fixed costs are business expenses that remain consistent regardless of your company’s output or productivity. Rent, property taxes, insurance, and most salaries are a few common examples of fixed costs.

Fixed costs differ from variable costs in a fundamental way: Variable costs fluctuate with your business activity. If you run a bakery, flour and yeast are variable costs because you need more as you bake more bread. Your rent, however, stays fixed whether you're having a slow Tuesday or a busy Saturday.

People often confuse these three expense categories:

• Fixed costs: Expenses that don't change with production levels, such as rent, insurance, and base salaries
• Variable costs: Expenses that rise and fall with business activity, such as raw materials, shipping, and sales commissions
• Overhead costs: A broader category that includes both fixed and variable costs needed to run your business, but not directly related to making your product

Understanding fixed costs in business

Fixed costs play a central role in your overall cost structure management. They act as your business's baseline expense level, the minimum amount you need to cover before turning a profit.

They're the bills you'll pay whether business is booming or slow. This helps you set realistic sales targets, determine your break-even point (BEP), and make informed decisions about expansion or cost-cutting measures.

When you combine fixed costs with variable costs, you get a complete picture of what it takes to run your operation. This combination helps you price products appropriately, plan for seasonal fluctuations, and identify opportunities to improve cost management.

Fixed cost examples and categories

Fixed costs stay constant regardless of your business activity level. They’re predictable but require careful management. Here are the most common types of business fixed costs you'll encounter:

Rent or mortgage

Facility costs represent one of the largest fixed expenses for most businesses. When you sign a commercial lease or take out a mortgage, you commit to paying the same amount each month regardless of how busy your business gets.

Consider a small marketing agency that signs a 3-year lease for office space at $3,500 per month. Whether they land 10 new clients or lose half their existing ones, that $3,500 payment remains due on the first of every month.

The agreement typically includes specific terms about rent increases, maintenance responsibilities, and renewal options, but the monthly payment stays predictable over the lease term.

Salaries

Salary expenses differ significantly from hourly wages when it comes to business fixed costs. Salaried employees receive the same pay each period, while hourly wages represent variable expenses that fluctuate with business needs.

A restaurant manager earning $60,000 annually represents a fixed cost. They receive the same paycheck whether the restaurant serves 100 customers or 500 customers in a week. The hourly kitchen staff and servers create variable costs since their pay depends on scheduled hours and business volume.

Insurance

Business insurance policies typically operate on fixed premium structures, making them predictable monthly or annual expenses. These policies protect your business against various risks, and premiums are calculated based on coverage levels rather than daily business activity.

Common fixed insurance costs include general liability coverage, property insurance, and workers' compensation base premiums. A consulting firm might pay $800 monthly for a comprehensive business insurance package that covers professional liability, general liability, and cybersecurity protection. Whether they complete five or 15 projects that month, this premium stays the same.

Depreciation and amortization

Depreciation and amortization spread the cost of long-term assets over their useful life, creating consistent monthly fixed expenses. Depreciation applies to physical assets, while amortization covers intangible assets such as patents.

When a graphic design studio purchases $15,000 worth of computer equipment, they don't expense the full amount immediately. Instead, they might depreciate it over 5 years, creating a fixed monthly expense of $250. This approach smooths out the financial impact and provides a more accurate picture of ongoing business costs.

Property taxes and utilities

Businesses pay property taxes on real estate they own annually, but they typically pay in fixed installments throughout the year. Property value determines these taxes rather than business performance, so they’re true fixed costs.

Utility expenses can be either fixed or variable. While electricity and gas usage typically vary with consumption, some businesses negotiate fixed-rate contracts. A small manufacturer might arrange a fixed monthly rate of $1,200 for electricity to avoid seasonal fluctuations and budget more effectively.

Fixed costs vs. variable costs

There are two types of costs: fixed and variable. Fixed costs remain constant regardless of your production level, while variable expenses fluctuate in direct proportion to your production volume or sales. So, as your level of production increases, your total variable costs increase.

Many variable costs fall into the bucket of cost of goods sold (COGS) since they fluctuate in direct proportion to your level of production and sales. Common examples include:

• Raw materials
• Utilities such as electricity and water
• Direct labor costs
• Marketing and advertising
• Commissions
• Shipping and freight
• Packaging costs
• Credit card processing fees
• Taxes and tariffs‍

Variable costs are less predictable because they change based on how much your business produces, which makes 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 costs, 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 costs = Total costs of production – (Variable cost per unit * Number of units produced)

For example, let's say you’re a manufacturing company that produces widgets. The total cost of producing 1,000 widgets is $10,000. The variable cost per widget is $0.50, based on the cost of raw materials, direct labor, and electricity. Here’s how you’d calculate your fixed costs:

Fixed costs = $10,000 - ($0.50 * 1,000) = $9,500

It's important to note that business 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.‍

How to calculate average fixed costs

To calculate your average fixed costs for a specific period of time, you’ll need to first identify the total fixed costs and the quantity of output over that period. Then, simply divide your total fixed costs by the quantity of output:

Average fixed costs (AFC) = Total fixed costs (TFC) / Quantity of output (Q)

This calculation gives you insight into how fixed costs are distributed per unit of output as production volume changes.

Special considerations for business fixed costs

Fixed costs can be trickier than they seem. The timing of when fixed costs appear on financial statements can vary significantly based on business decisions and accounting methods. You might prepay rent for several months, spreading the expense across multiple reporting periods, or depreciate equipment purchases over several years.

Fixed costs play a major role in shaping your company's operating leverage and cost structure. When a business has high fixed costs relative to variable costs, small changes in revenue can create dramatic swings in profitability.

Some fixed costs are truly locked in for extended periods, such as long-term lease agreements, while others can be adjusted more readily, such as monthly software subscriptions.

Operating leverage

Operating leverage measures how sensitive a company's operating income is to changes in sales revenue. When your business has high fixed costs, revenue changes are more pronounced and flow through to profitability because you have to pay fixed costs regardless of sales performance.

Consider a small manufacturing business with monthly fixed costs of $50,000 and variable costs of $20 per unit. If they sell 1,000 units at $75 each, their profit is $5,000:

• Revenue: 1,000 units * $75 = $75,000
• Variable costs: 1,000 units * $20 = $20,000
• Fixed costs: $50,000
• Profit: $75,000 – $20,000 – $50,000 = $5,000

When sales increase by 20% to 1,200 units, profit jumps to $16,000, a 220% increase from just a 20% bump in sales:

• Revenue: 1,200 units * $75 = $90,000
• Variable costs: 1,200 units * $20 = $24,000
• Fixed costs: $50,000
• Profit: $90,000 – $24,000 – $50,000 = $16,000

This amplification effect makes operating leverage a double-edged sword. Companies with high fixed costs can achieve impressive profit growth during good times, but they're also more vulnerable during downturns.

Sunk costs

Sunk costs represent money already spent that you can't recover, regardless of future decisions. While related to fixed costs, they're not identical, and the distinction matters for decision-making.

You can’t change a sunk cost, such as research and development spending on a failed product, because you’ve already incurred it. Fixed costs are ongoing expenses that don't vary with production but may still be adjustable over time, such as annual software licensing fees.

When evaluating business decisions, ignore sunk costs completely since you can’t recover them. Fixed costs might be relevant if you can avoid them in the future. For example, money spent on kitchen equipment is a sunk cost, but monthly rent is a fixed cost you might be able to lower.

The impact of fixed costs on your finances

Tracking fixed costs is crucial for small business owners because it forms the basis for effective financial planning and decision-making. In particular, a clear understanding of your fixed costs allows you to set accurate budgets and calculate important financial metrics such as your break-even point.

How to calculate your break-even point

Your break-even point is when your company no longer operates at a loss. In other words, your BEP is when your total expenses and your total revenue are equal. BEP is an especially important metric for startups and other new businesses because it helps you chart a path toward profitability.

To run a break-even analysis, you’ll need your total business fixed costs, your revenue per unit sold, and your variable cost per unit. Then, you can use this formula to calculate your break-even point:

Break-even point = Total fixed costs / (Revenue per unit – Variable cost per unit)

Understanding your break-even point provides a clear sales target for profitability, helping you make informed decisions about pricing, costs, product development, and growth strategies while creating financial viability.

How to monitor and control fixed costs in your business

Managing fixed costs effectively requires a proactive approach and regular attention to detail.

• Review all fixed expenses quarterly to identify any unnecessary services or subscriptions that can be eliminated
• Negotiate contract renewals well in advance to secure better rates on insurance, utilities, and vendor agreements
• Consider flexible lease arrangements or co-working spaces instead of traditional long-term office commitments
• Implement automated tracking systems to monitor fixed cost changes and flag any unexpected increases
• Bundle services with single providers when possible to leverage volume discounts on telecommunications and utilities
• Regularly benchmark your fixed costs against industry standards to identify areas for improvement
• Create approval processes for any new recurring expenses to prevent fixed cost creep over time
• Explore technology solutions that can replace multiple fixed cost items, such as cloud-based software replacing hardware maintenance contracts

Use Ramp to manage your company's fixed costs

Accurately tracking all your expenses is the first step toward managing your business’s fixed costs, and the right financial tools make that process a lot easier.

Ramp’s comprehensive expense management platform streamlines how you track spending and monitor cash flow. Ramp integrates with leading accounting software such as NetSuite and QuickBooks, making budgeting, planning, and financial reporting easier and more accurate.

Automated business expense categorization instantly classifies expenses so you can easily pull up a list of all your fixed expenses whenever you need to see them. Ramp’s modern finance platform saves you time and lets you get back to what’s most important: driving growth and profitability.