Last editedJun 20212 min read
Understanding your business cash flow is crucial in understanding your business finances. This means more than just accounting for what’s coming into your business. You also need to account for your costs. The trouble is that costs can be hard to keep track of because they’re so varied. Whatever your business costs, they usually fall into two categories – fixed costs and variable costs.
Fixed costs are static and do not change from one month to the next. Variable costs, however, are in a constant state of flux. Only when you can anticipate both effectively can you get a firm understanding of your bottom line and manage your cash flow effectively.
Both fixed and variable costs are essential to managerial accounting. They are often used in financial reporting to get a clearer understanding of a company’s financial health.
Understanding fixed costs
Fixed costs are just that – fixed. These are what you traditionally think of when you think about your overheads. They are usually time-related and remain the same month-on-month (either indefinitely or for a fixed period).
Fixed costs are easy to anticipate and account for due to their consistency. However, the more fixed costs a company has, the more recurring revenue it needs to make in order to break even. No matter how much or how little you produce or sell, your fixed costs remain the same.
However, it’s a fallacy to assume that fixed costs are constant in the long run. If you scale up your business premises or your SaaS tools, for example, your fixed costs will increase. Likewise, if you promote a member of your team, the fixed cost that is their salary will increase.
Fixed costs examples
Common examples of fixed costs for SMEs include:
Rent for your physical premises
Web hosting costs
Monthly / annual SaaS subscriptions
Telephone and internet costs
Understanding variable costs
Rather than being time-based, variable costs are volume-based. This means they may fluctuate depending on how much volume of products or services your business produces and how your business performs.
While variable costs can be harder to predict than fixed costs, you can use a simple formula to get a ballpark figure.
All you need to do is multiply the quantity of output by the variable cost per unit of your output. However, this does not take into account any ancillary costs such as labour and raw materials.
Although variable costs can be harder to account for, they are easier for businesses to control. For instance, your business energy spend is a good example of a variable cost. You can exert control over this by finding ways to use less energy or switching to a new energy supplier.
Variable costs examples
Common examples of variable costs for businesses include:
Energy and water costs
The cost of shipping goods to customers / retailers
Plant repair and maintenance costs
Using fixed and variable costs to your advantage
Gaining a clear understanding of your fixed costs is useful for identifying break-even costs. When you know what sort of top line you should be aiming for, you can strategise accordingly, increasing production while lowering variable costs where possible.
This enables businesses to create economies of scale, gradually reducing their costs per unit and gaining a pricing advantage over their competitors.
We can help
If you’re interested in discovering more about fixed costs, variable costs, cash flow, or any aspect of your business finances, then get in touch with our financial experts. Find out how GoCardless can help you with ad hoc payments or recurring payments.