Understanding and Distinguishing Between Fixed and Variable Costs

Key Difference Between Fixed Costs and Variable Costs: Business Context

Managing your small business finances means tracking expenses, understanding revenue, and accurately calculating profitability.

Central to this process is knowing the difference between fixed and variable costs in business—two critical components that influence pricing strategies, operational efficiency, and overall profitability.

What is the difference between fixed and variable cost?

Fixed costs—such as rent, salaried employee wages, and insurance premiums—remain constant regardless of production volume, while variable costs—including supplies, raw materials, hourly wages, and sales commissions—fluctuate based on business activity.

At Unity Business Advisors, we help small business owners apply these cost insights through strategic planning and expert business advisory services, empowering smarter decisions and sustainable growth.

👉 Start with expert business advisory—schedule your consultation with Unity Business Advisors today.

What Are Fixed Costs?

Fixed costs are expenses that remain consistent regardless of sales or production levels. Whether your business is growing or experiencing a slower period, these costs typically stay the same.

Common examples of fixed costs include:

• Rent or mortgage payments
• Insurance premiums
• Salaries of full-time employees
• Loan repayments

Because fixed costs are predictable, they help with long-term planning—but they can pressure cash flow during slower months if not managed strategically.

What Are Variable Costs?

Variable costs are expenses that change day to day, month to month, and year to year based on the level of business activity, increasing with higher production or customer demand and decreasing as activity slows.

Therefore, variable costs fluctuate directly with your business’s activity level. As sales or production increase, these costs rise; when activity slows, they decrease.

Typical examples of variable costs include:

• Hourly wages for part-time or contract workers
• Shipping and delivery fees
• Utilities based on usage
• Raw materials and supplies

Variable costs offer flexibility but can make budgeting more complex without clear tracking and forecasting. These costs fluctuate based on production levels or business activity and typically include items such as supplies, materials, and hourly labor.

How to Distinguish Between Fixed and Variable Costs

The primary distinction lies in how these costs respond to changes in business activity:

• Fixed costs provide stability and predictability but can strain profitability when revenue declines.
• Variable costs adjust with sales volume, offering flexibility but sometimes leading to unexpected spikes.

Some expenses—such as labor and utilities—can fall into both categories depending on how they are structured.

Are Labor Costs (Salaries/Wage) Fixed or Variable?

Payroll costs—including labor costs such as salaries, wages, and commissions—can be either fixed or variable depending on the employee type.

Salaried employees typically represent fixed payroll costs since their compensation remains constant regardless of business activity.

In contrast, hourly or commission-based wages fluctuate based on the level of work performed or sales made, making them variable costs that rise and fall with business volume.

Simply put:

• Fixed labor costs: Salaried employees and consistent administrative staff
• Variable labor costs: Hourly workers, overtime pay, commissions, seasonal or contract labor
• Mixed labor costs: Base salary plus commission or guaranteed hours with overtime

Knowing how labor costs and payroll expenses behave is critical for budgeting. Fixed salaries provide stability, while variable wages and commissions require flexible forecasting.

Why Would Labor Be Treated as a Variable Cost?

Labor is often treated as a variable cost when employee hours or wages fluctuate based on production levels or demand. In industries that rely on hourly workers, overtime, or contract labor, labor costs rise and fall with output, making them variable rather than fixed.

Understanding this distinction allows business owners to better forecast expenses and align staffing with demand—an area where strategic business advisory support can be especially valuable.

Are Utilities Fixed or Variable Costs?

Utilities are often mixed costs:

• Base service or connection fees are typically fixed
• Electricity, water, and gas usage varies based on operating hours or production levels

Tracking both components helps businesses control operating expenses more effectively.

Why Understanding These Costs Matters

Knowing the difference between fixed and variable costs helps you:

• Set pricing strategies that fully cover expenses
• Improve profitability by identifying cost-reduction opportunities
• Enhance operational efficiency through better expense tracking
• Maintain financial stability during revenue fluctuations
• Help you reduce overhead expenses and improve profitability.

Many business owners work with business advisory services to translate these insights into actionable financial strategies.

Turn Cost Knowledge Into Strategic Action

Understanding fixed and variable costs is only the beginning. Utilizing this knowledge effectively requires forward-looking planning, forecasting, and decision-making.

If you need help applying these concepts, our business advisory team provide strategic guidance tailored to your business.

Schedule your business advisory consultation with Unity Business Advisors today to turn cost insights into smarter strategies and long-term business success.