Tracking your expenses over time is important not only for financial forecasting, but also to create a more accurate budget. Fixed costs form an important component of any business’s expenses. So, what is fixed cost, and how is it calculated?
What is fixed cost?
Any expense that remains static over time is referred to as a fixed cost. Unlike variable costs, which are related to production, fixed costs aren’t dependent on any other factor. They’re often regular expenditures like rent or utilities, which remain the same from month to month.
How to calculate fixed cost
Variable costs require you to calculate the variable cost per unit, and then multiply this by the number of units produced in a given accounting period. By contrast, learning how to calculate fixed cost is quite straightforward.
Fixed cost formula
To calculate total fixed cost, you simply add together all the individual fixed costs in the accounting period.
Written as a fixed cost formula, it would look like this:
Total Fixed Cost = Sum of Individual Fixed Costs
To put this into practice, you’ll first need to define the fixed costs your company has incurred and determine the boundaries of your accounting period. With these two variables in hand, you can add together the total fixed cost.
Fixed cost examples
What exactly qualifies as a fixed cost? There are many different expenses that are unrelated to production levels, but still part of a business some fixed cost examples include:
Tax filing costs: If you pay for an accounting firm, this cost remains separate from production levels.
Cost of training staff: Training costs are fixed because they are also unrelated to production.
Paying rent on your premises: No matter how many units you produce, the rent will most likely stay the same from month to month.
Cost of machinery and equipment: If the equipment is intended for long-term use, this type of asset would be considered a fixed cost. By contrast, the type of supplies that you burn through as part of production (toner ink, machinery oil) would be variable.
Employee salaries: Salaries are paid on an annual basis, so they are considered fixed even if you give your employee a raise over time. On the other hand, if you pay sales bonuses or commissions, these are considered to be variable costs because they’re tied to production.
Depreciation: An asset’s loss of value occurs over time and is gradually charged to expenses as a result.
Interest charges: If you’ve taken out business loans, the cost of interest is considered a fixed expense.
Utilities: Expenses like internet, water, electricity, and heating are all fixed costs for accounting purposes. Although these might vary slightly according to use, they’re predictable, usually similar expenses from month to month.
Can fixed costs change?
In short, yes. A few of the fixed cost examples above might fluctuate, such as utility charges and rental costs. These types of expenses are sometimes called semi-variable. However, if they change only temporarily, they could still be considered fixed.
Why is knowing the fixed cost important?
Understanding fixed cost is important both for budgeting purposes and balancing the books. It’s also helpful to keep track of fixed cost in order to project profits. In many cases, businesses with higher fixed costs might take longer to reach the break-even point, but after this they enjoy low costs of production.
One example would be a commercial printing press. Once you’ve paid off the cost of machinery and equipment, you can start generating higher profits provided the variable costs are low. This is why you should consider both variable and fixed costs together when looking at ways to potentially cut expenses down and generate greater profit.
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