Understanding Fixed vs. Variable Costs in Your Small Business

Keeping track of expenses, understanding revenue, calculating profitability–there’s a lot involved in the effective financial management of your small business, and the key to success is understanding fixed and variable costs. Not only are these two categories critical in day-to-day operations, but they also play a major role in helping set pricing strategies, boosting efficiency, and enhancing profitability.

Unity Business Advisors is here to help you learn about the differences between fixed and variable costs so you can set your business up for financial success.

What Are Fixed Costs?

Fixed costs refer to the expenses of your small business that remain constant regardless of production level or sales. From busy seasons to slower periods, fixed costs should generally stay about the same.

Examples of fixed costs include:

• The rent or mortgage payment for your business space
• Insurance premiums
• Salaries of full-time employees
• Loan payments

Because fixed costs don’t fluctuate based on business performance, they help provide a predictable, constant expense framework. However, that also means that should your business have a less profitable month or two, fixed costs will further decrease your profitability for that timeframe.

What Are Variable Costs?

Variable costs are the expenses that change in proportion to your business’s sales volume. They include:

• Hourly wages for part-time or contract employees
• Shipping and delivery costs
• Utility expenses, if they vary with production needs
• Raw material/supplies

As production or sales go up, so do variable costs. Conversely, when business slows down, variable costs decrease. The flexible nature of these costs can make them an unpredictable part of your small business budget and harder to account for.

Key Differences Between the Two

The main difference between the two types of business costs is how they’re tied to performance or sales. While fixed costs tend to remain steady no matter how your business is doing, variable costs fluctuate based on activity levels.

You’ll no longer have to wonder, “Is labor a fixed or variable cost?” You know that salaries of full-time employees are fixed and hourly wages for part-time workers are variable. Same with utilities, are utilities a fixed or variable cost? Knowing the difference between the two means knowing they can be both, depending on whether or not your goods or services are tied to utilities.

In addition to simply being more knowledgeable about business expenses, knowing the difference between these two helps plan your budget. Fixed costs help provide budgeting consistency but can also reduce profitability during slower periods; variable costs offer more flexibility in your budget but could lead to spikes when demand is high.

Why It Matters

Understanding the difference between these two business expenses can help you more accurately predict what your costs will be in different scenarios. Those key insights help you develop more accurate planning and forecasting. But that’s not the only benefit of knowing the difference between fixed and variable costs. Other key advantages include:

1. Informs pricing strategies: By understanding fixed and variable costs, you can make more informed decisions when setting prices, covering both types of expenses.

2. Boosts profitability: Effective fixed and variable cost management can lead to maximized profits. When you eliminate unnecessary variable costs or find ways to reduce fixed ones, you can increase your profitability.

3. Enhances efficiency: A known cost is one that can be closely monitored. By tracking your variable costs, it becomes easier to optimize processes and implement money-saving solutions. For example, bulk pricing may reduce unit costs, while efficient scheduling could cut back on labor costs.

4. Supports financial health: Understanding these costs helps you build and maintain a stronger financial foundation that’s less susceptible to busy periods and lulls. A clear grasp of fixed and variable expenses can help you make more informed business decisions.

Take Control of Your Financial Health With Unity Business Advisors

Leave fixed and variable cost management to our team of financial experts. We’ll handle your accounting and advisory needs to ensure your small business continues to run smoothly, freeing you up to focus on what truly matters–your company. Connect with Unity Business Advisors today!