Difference Between Fixed and Variable Costs

Edited by Diffzy | Updated on: September 21, 2022

       

Difference Between Fixed and Variable Costs Difference Between Fixed and Variable Costs

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Introduction

Depending on the nature of the cost, it can be characterized in a variety of ways. Any expense incurred by a firm throughout the manufacturing or production process for its goods and services is referred to as cost. Understanding the difference between costs and income is crucial to determining your company's profitability. The categorization of fixed and variable expenses is one of the most used ways. When businesses manufacture items, they suffer two sorts of expenses: variable and fixed costs. Fixed costs do not vary when the volume of units of production rises or decreases, but variable costs fluctuate as the volume of units of production increases or decreases. Fixed cost is defined as a cost that does not fluctuate as the number of items produced by a company increases or decreases. Variable costs change according to the number of units produced.

Any expenditures that fluctuate depending on how much a firm produces and sells are considered variable expenses. This indicates that variable costs climb with increased output and decline with decreased production. Fixed and variable costs are important words in management accounting, and they're employed in a variety of financial statement analyses. Fixed costs are used by businesses for expenses that do not change over time. The variable cost of production is a fixed sum for each item produced, which varies depending on production.

Fixed Costs vs. Variable Costs

Costs are a major determinant of a company's overall profitability, and a company's whole cost structure is made up of fixed and variable costs. Variable expenses are more difficult to plan, manage, and budget for than fixed expenditures. Costs of packaging Materials used in the manufacturing process Costs of utility Costs of direct labor. Variable cost, as opposed to fixed cost, is determined by the company's operations and productivity. Salaries, power bills, production prices, and so on are examples of variable costs. Interest on fixed capital, license fees, permanent staff salary, and other fixed expenditures are included in the fixed costs. These variables do not influence manufacturing output.

Variable expenses, on the other hand, are directly tied to the amount of output and include power and fuel charges, salaries to casual staff, interest in working capital, and so on. As a result of the above statement, variable costs are the determining factors. Fixed costs have no relationship with output since they stay constant regardless of production level. Variable costs, on the other hand, are positively connected to production. Variable costs will be 0 if production is zero, and vice versa.

The nature of the expenditure

Understanding the volatility of expenses and how they relate to your sales volume will help you make informed business decisions that will eventually generate profits since fixed and variable costs make up the cost structure of your firm. Fixed expenses are proportional to the passage of time. In other words, they remain consistent throughout time, and businesses understand that they must budget for those fixed costs since they will be due at regular periods. Variable costs are proportional to output and are quantity-related.

Difference between Fixed and Variable Costs in Tabular Form

Table: Fixed Costs vs. Variable Costs
Parameters of Comparison
Fixed Cost
Variable Cost
Definition
Variable/changing costs based on the company's output volume
Costs that remain constant regardless of manufacturing volume
Nature of cost
It is temporally dependent and changes after a specific amount of time has passed.
It is volume-dependent and varies according to the amount of material generated.
When Productivity Rises
The total variable costs rise.
The total fixed cost remains constant.
Profitability impact
Increased output lowers expenses and raises profits.
With the level of output, there is no effect on profit.
Examples
Depreciation, rent, salary, and insurance, among other things
Consumption of materials, wages, sales commissions, and so on

What is Fixed Cost?

Fixed expenses are costs that are not related to the amount of activity. Any rise or fall the level of activity does not affect this cost. Fixed cost is the cost that remains constant at varying levels of production generated by a company. They are unaffected by the organization's activity levels fluctuating from time to time. Fixed cost is the cost that remains constant at varying levels of production generated by a company. They are unaffected by the organization's activity levels fluctuating from time to time. Fixed costs are expenses that a corporation must pay regularly and are usually time-related. Regardless of the production or volume of business activity, it remains constant for a set length of time. Also known as indirect, supplemental, or overhead charges. Fixed costs are less manageable than variable costs since they aren't affected by production factors like volume.

Fixed costs include rent, salary, and property taxes, to name a few. Fixed costs are expenses that are set in stone for a defined length of time and are unaffected by the performance of the firm. Because most firms will have some fixed costs regardless of whether or not they conduct business, they are easier to budget for because they remain consistent throughout the fiscal year. Regardless of productivity, every firm has some fixed costs. These fixed expenditures are easy to budget for since they are consistent throughout the year. They are, however, less manageable than variable expenses since they are not tied to the amount of production or activities. The notion of fixed expenses assists businesses in determining their breakeven point, or the number of sales necessary to earn no profit and no loss.

The more a company's fixed costs are, the more revenue it requires to break even. There will never be a day when fixed costs are zero. There will be no variable expenses in the short term when manufacturing is temporarily halted. As a result, the variable expenses will be nothing. Regardless of whether a company generates or not, fixed expenses will never be zero. The fixed costs are always positive.

There are two types of Fixed Costs:

  • Committed Fixed Cost
  • Discretionary Fixed Cost

Committed Fixed Cost

The expenses of maintaining present production capacity are known as committed fixed costs, or capacity costs. These expenses are the result of senior managers' long-term decisions on the size and type of their company. As a result, regardless of activity level, they remain the same in total. The quantity of resource capacity obtained, not the amount of resource capacity used, determines the size of a committed cost.

Discretionary Fixed Cost

Managerial policy decisions result in discretionary fixed costs, often known as controlled costs or planned costs. Unlike fixed expenses that are committed, discretionary fixed costs fluctuate over time. These expenditures are normally established at a preset sum each year by managers.

Costs that fall under this category cannot be removed indefinitely. Instead, they are frequently costs that are minimized or set aside temporarily to help with the short-term bottom line.

What is Variable Cost?

Variable costs are costs that are related to some activities. Any rise or fall in the level of activity will lead to a change in this cost. A company's fixed cost is the expense that remains constant regardless of the amount of production it generates. They are unaffected by the varying activity levels of the organization. Variable cost refers to a cost that fluctuates as the number of goods generated changes. The swings in the enterprise's activity levels have a direct impact on them. Variable cost changes with variations in volume, i.e., when output increases, variable cost increases proportionately by the same percentage, and when production does not rise, there is no variable cost. Even though overall fixed costs remain constant, the fixed cost per unit fluctuates as the number of units increases. The phrases fixed costs, variable costs, and others are used differently in business planning and management accounting than they are in economics, and this might vary depending on the situation. The idea of variable costs aids in computing the profit contribution, which aids in calculating the breakeven point, i.e., the number of sales necessary to generate no profit and no loss.

For profitability purposes, certain cost accounting approaches, such as activity-based costing, would allocate fixed expenses to business activities. The variable cost is related to the number of units produced by the company. Variable expenses will naturally be lower if the company's production is low. However, if the business is in full swing, the variable expenses will be considered as well. The higher a company's fixed expenses are, the more income it must earn to break even, which means it must work more to manufacture and sell its products. This is because these expenditures occur regularly and seldom alter over time. While variable expenses tend to stay the same, the impact of fixed costs on a company's bottom line varies depending on how many goods it produces. As a result, as output grows, fixed costs decrease.

The expense of a larger quantity of items can be stretched out over the same fixed cost. The producer is compelled to sell the commodity at a cheap price because of a drop in demand. In this case, the manufacturer will sell the product as long as the variable expenses are covered. He will not be concerned about fixed expenses because he must face them even if production is zero.

The variable cost is broken down into two categories:

  1. Cost Variable Direct
  2. Variable Cost Indirect

Cost Variable Direct

A direct variable cost is a sort of direct cost that is proportional to the amount of activity, i.e., if more units are produced, the cost will grow, and if fewer units are produced, the cost will fall. Direct costs, such as direct labor and direct material costs, are expenses that may be directly linked to the manufacturing of a product. Fixed expenses, such as the rent for a manufacturing site, are examples of direct costs.

Variable Cost Indirect

A direct fixed cost is directly tied to the manufacturing process or service delivery but does not fluctuate depending on the activity level. Even if more or fewer units are manufactured, the cost will stay the same. Raw materials and machinery supply are examples of variable costs that fluctuate depending on the degree of industrial output. Because variable costs can't be related to a single product, they might also include indirect expenditures like power for the manufacturing plant.

The main difference between Fixed and Variable Costs In Points

  • Fixed cost is a cost that does not change when the number of produced units changes. Variable Cost refers to a cost that changes as the quantity of produced units changes.
  • The fixed cost is time-related, in the sense that it does not change over time. Unlike Variable Cost, which is volume-based, that is, it fluctuates as the volume changes.
  • Fixed costs are unchangeable; they will be incurred even if no units are generated. Variable Cost, on the other hand, is not fixed; it will only be incurred if the company produces something.
  • Changes in fixed costs per unit. Variable cost, on the other hand, remains constant per unit.
  • Fixed costs are carried by the company throughout its functional time, whereas variable costs fluctuate depending on the firm's operations and productivity.
  • Variable cost grows and drops at regular periods, whereas fixed cost remains relatively constant over time.
  • Fixed costs are consistent since they must be paid to keep the firm running, whereas variable costs are incurred based on the company's productivity.

Conclusion

The variable cost of a product is calculated by dividing the total variable expenditures by the number of units available for sale. Divide the total fixed cost by the number of units for sale to get the fixed cost per unit.

If you want to limit risk while taking out a loan, stable interest rates are often a better alternative than variable interest rates. This is because variable rates can fluctuate monthly or quarterly and are dependent on changing economic conditions. Fixed rates, on the other hand, do not alter during the life of the loan. Now, based on the above explanation, it should be evident that the two expenses are opposed to one another and are not comparable in any way. There are many questions when it comes to these two, but you will undoubtedly be happy after reading this post. So that's it for the Fixed Cost vs. Variable Cost distinction.

References

  • The Difference Between Fixed Cost and Variable Cost - Online Accounting (online-accounting.net)
  • Fixed vs. Variable Costs: Definitions and Examples | Indeed.com
  • Direct Cost, Variable Cost, Fixed Cost, Indirect Cost - BUSINANCE

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"Difference Between Fixed and Variable Costs." Diffzy.com, 2022. Sun. 02 Oct. 2022. <https://www.diffzy.com/article/difference-between-fixed-and-variable-costs-650>.



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