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What Is The Difference Between Variable and Fixed Costs?

Both variable costs and fixed costs are elements of the total costs that a company incurs when they are producing goods or providing services. The reason that costs are split into these two categories is to measure how these costs behave as the production or sales levels. This blog post goes into the details of what makes these costs different, how to calculate these costs and examples of costs that would fit into each category.

Fixed Costs:

Fixed costs are the expenses that remain the same regardless of changes in the level of production or sales. They stay constant regardless of increases or decreases in production, this makes them easier to identify and calculate. These are the costs that remain constant even if the company produces nothing.

Examples of fixed costs include:

  • Rent for facilities
  • Salaries of permanent employees (not tied to production levels)
  • Insurance premiums
  • Depreciation of fixed assets
  • Property taxes.

How to calculate fixed costs:

Step 1: Identify what expenses are fixed. The rule of thumb is that these expenses do not vary with changes in production or sales.

Step 2: Collect any relevant financial records and invoices that detail the cost of these fixed expenses. These could be bookkeeping records, lease agreements, utility bills, payroll records, insurance statements

Step 3: Once you have identified all of your fixed expenses you can add them together to calculate the total fixed cost for a specific period, such as a month, quarter, or year.

Total Fixed Costs = Fixed Expense 1 + Fix Expense 2 + …

If you know your total cost and your variable cost there is another simple formula to calculate fixed cost:

Fixed Cost = Total Cost – (Variable Cost Per Unit * Units Produced)

Step 4: Double-check your calculations to ensure accuracy. It’s crucial to accurately identify and sum up all fixed expenses to get an accurate picture of your total fixed costs.

Variable Costs:

Variable costs are costs that fluctuate with the level of production or sales. As production increases, variable costs will also increase; as production decreases, variable costs also decrease.

Examples of variable costs include:

  • Raw materials
  • Direct labour (wages for workers directly involved in production)
  • Utilities (like electricity and water) that are directly tied to production
  • Sales commissions based on the volume of sales

How to calculate variable costs:

Step 1: Make a list of expenses that fluctuate with changes in production or sales.

Step 2: Collect any relevant financial documents or invoices that outline your variable expenses. Such as purchase orders, payroll records, utility bills, and sales commission reports.

Step 3: Once you have identified all of your variable expenses, add them together to calculate the total variable costs for the specific period you are analyzing.

Total Variable Costs = Variable Expense 1 + Variable Expense 2 + …

Another alternative to calculating total variable costs is:

Total Variable Cost = Total Quantity of Output x Variable Cost Per Unit of Output

How LedgersOnline Can Help

Understanding the difference between variable and fixed costs is important for businesses because it helps in analyzing the cost structure, making pricing decisions, determining break-even points, and managing profitability. By knowing how costs behave under different circumstances, businesses can make informed decisions to improve their operations and financial performance.

Need help creating and analyzing financial reports? LedgersOnline offers a financial reporting service that helps you access accurate and timely financial information, allowing you to make data-driven decisions with confidence. Schedule a call to see how our team can help.

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