Every company incurs costs during its operations. It is impossible to think about a company with no cost. The companies therefore must be aware of the costs because the unnecessary costs may harm the financials absurdly. Saving funds by managing costs efficiently goes a long way in making a company profitable. That is why knowing more about costs is important for everyone.
A company usually makes two types of costs depending on the nature of change along with the production volumes of the company.
These two types of costs are −
Fixed cost refers to costs that remain unchanged for the company for a long period of time. They are usually independent variables. These costs remain the same for a considerable period as they are usually related to the fixed assets of a firm. Regardless of the operations and productivity, these costs must be borne by companies all the time.
A good example of fixed cost is the commercial rent for the structure occupied by the company.
Fixed cost remains unchanged for a considerable period of time and has to be paid irrespective of whether the company makes a profit or not in the case of fixed costs.
Moreover, the company has to pay this cost throughout its operational period without any palpable change whatsoever.
Although fixed costs may be subject to change, it is often rare to notice. This is so because it is often hard to see any palpable change in the cost structure of the fixed assets of a company. Since the assets on which costs are based do not change, the total cost arising due to the assets do not change too.
As noted, fixed costs do not change irrespective of whether the company produces goods or services or not. So, a company’s fixed costs do not change with the volume of production. These costs are indirect which means that the costs do not apply to the process of production.
Some very common examples of fixed costs include property tax, lease and rent payments, certain salaries, depreciation, insurance, and interest payments.
Fixed costs are usually time-dependent in nature. They occur periodically and the companies can plan for them.
Unlike variable costs that are volume-dependent, fixed costs are incurred at a given point in time, and the expenditure is known to the firm’s owners beforehand.
Variable costs are of the nature of frequent change depending on the nature of the costs. These costs are direct, meaning that they are directly linked with the production volume of a company. Therefore, when a company increases the variable cost goes up while when the production is reduced, the variable costs come down.
Some common examples of variable costs are costs associated with Commissions, Packaging, Labor, Utility expenses, Raw materials for production, etc.
It can be noted that variable costs are the costs associated with short-term expenses. These expenses are subject to change more often than usual. In contrast to fixed costs, variable costs change more frequently and hence it is hard to plan for variable cost management.
Variable costs are related to the outputs produced. As more expenses must be incurred to get more output, variable costs are considered as of changing nature. These costs are more or less related to common expenses that are made routinely by a company.
Variable costs may also be considered as day-to-day expenses of a company. Although expenses made by companies as variable costs are not permanent in nature, they play an important role in the operations of the firm. Therefore, having the knowledge of variable costs incurred by the company is important for the management to manage the firm efficiently.
Furthermore, it is important to note about variable costs is that they are not comparable across industries. The variable cost of a computer chip manufacturer is therefore different from the variable costs of a car manufacturer. This is so because the product outputs of car manufacturers and chip manufacturers are different. So, if variable costs are needed to be compared, the businesses must be in the same industry.
| Fixed Cost | Variable Cost |
|---|---|
Fixed costs are costs that do not change with the changing volume of production of a firm. The volume, when increases, show better productivity though. | Variable costs change with the change in the volume of production. There is a change in productivity with changing volume in the case of variable costs. |
Fixed cost is based on time. It is time-dependent and change after a certain period of time. These costs are therefore made daily, weekly, monthly, or on a yearly basis depending on the nature of the cost. | Variable costs are dependent on the volumes manufactured. The costs change depending on the production volume and there is nothing related to time in the case of variable costs. |
Fixed costs are costs of total production. They don’t have anything to do with the number of units produced. This means that the cost of production stays the same even when the number of units produced is increased. | Variable costs are costs per unit of production. It is the cost of each unit that is produced. That is why, when production goes up, the costs also go up. |
Fixed costs usually go down with an increase in the number of production. As the production goes up, the per unit cost comes down which decreases the total cost of the process. | Variable costs do not change with an increase in volume. It will remain the same per unit even when the production goes up. |
In the case of fixed costs, higher production leads to more profitability as the cost per unit comes down. | The profitability does not change in the case of variable costs even when production goes up. This happens because the per unit cost remains the same. |
Some examples of fixed costs are salaries, rent, and property taxes. | Examples of variable costs include the cost of raw materials, labor costs, and sales commissions. |
Having knowledge of costs incurred by a company is a subject of major importance for the management. As costs are a major constituent of profitability, managers tend to keep costs as low as possible. However, to do so, one must know various types of costs and how and when to incur them.
The idea of fixed and variable costs is therefore important to have for a better knowledge of production and profitability. Managers of companies know this and they keep track of both types of costs to manage a firm effectively.
Q1. What happens to fixed and variable costs when production goes up?
Ans. Fixed costs usually go down with an increase in the number of production. As the production goes up, the per unit cost comes down which decreases the total cost of the process. Variable costs do not change with an increase in volume. It will remain the same per unit even when the production goes up.
Q2. Give two examples each of fixed and variable costs.
Ans. Fixed costs- rent, property taxes, Variable costs- commissions, labor costs.
Q3. Why are fixed costs called indirect costs?
Ans. Fixed costs are called indirect costs because they are not directly related to the volume of the production of a firm.
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