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Understanding fixed costs and how they impact the day-to-day operations is essential for anyone looking to start or expand a business.
Think of it as those expenses that are always there, no matter how much gets sold. Typical examples include office or shop rent, employee salaries, property taxes, and any licenses or professional memberships.
For small business owners, managing fixed costs effectively can be the difference between survival and profitability. Whether you’re running a café, a boutique, or a consulting firm, keeping track of these expenses can help with everything from budgeting and pricing strategies to long-term financial planning.
Below is a breakdown of everything an entrepreneur needs to know about fixed costs, how to calculate them, and what role they play in financial statements.
Fixed costs are expenses that stay the same regardless of how much a business makes or sells. Predictable and consistent, these fixed costs make budgeting, forecasting, and cash flow management easy as expenses remain the same and roll in at regular intervals.
Unlike operating expenses, which may fluctuate, fixed costs don’t change with production or service delivery volumes. For example, rent remains the same monthly whether the factory produces 100 or 1,000 units.
Fixed overhead costs are expenses that come in regardless of business performance. They’re often related to keeping the lights on and the business operating.
But not all fixed costs are also overhead costs. Fixed cost examples that are part of overhead include rent, utilities, and insurance expenses — all necessary to keep the business running.
On the other hand, non-overhead fixed costs, such as loan repayments, don’t contribute directly to day-to-day operations. While business-related, they’re tied to financing decisions rather than the operational needs of a company.
Variable costs are expenses that go up or down depending on how much a business produces or sells. Common fixed costs in a business include sales commissions, employee overtime, raw materials, and delivery or freight fees. When added together, you get total fixed costs, which change in direct relation to a business’s output.
Fixed costs don’t change with the volume of production or sales. But fixed costs vary depending on the levels of business activity. For example, the more units manufactured, the greater the cost of raw materials, energy, and freight to produce the increased number of units.
Understanding the difference between fixed and fixed costs can dramatically impact future business decisions and a company's profitability. Indeed, they both impact planning, budgeting, forecasting, and even pricing decisions. For example, a business with higher fixed costs, such as rent, may want to boost sales volumes to spread this cost over more units, reducing the cost per unit overall.
Or, consider a manufacturing company that leases specialized equipment. Even if production slows down, lease payments remain the same — making them a significant fixed cost. In contrast, expenses such as raw materials and packaging fluctuate based on production levels, making them fixed costs.
When planning profitability, understanding these differences is crucial for conducting a break-even analysis. This analysis helps business owners determine the minimum revenue needed to cover both fixed and fixed costs, offering clear insight into pricing strategies and cost management.
Learning how to calculate fixed costs is fairly straightforward. The following steps explore two approaches a business can use to calculate its fixed costs.
Now you have your fixed cost formula: Fixed costs = Fixed Cost 1 + Fixed Cost 2 and so on.
This is your variable cost formula which you can use to calculate your fixed costs: Fixed costs = Total Cost - Total Fixed costs.
Effectively managing fixed costs is essential for business financial health and long-term growth. Keeping these expenses under control helps maintain stability, improve profitability, and ensure sustainable operations.
Accurately tracking fixed costs provides a predictable base for any business to create a reliable financial forecast. By understanding each fixed cost, they can set realistic sales and revenue targets to cover the costs and turn a profit.
While necessary for every business, this is particularly important when planning for seasonal businesses or those facing fluctuation in sales. A well-structured budget for business ensures essential expenses are covered even during slower periods, helping to maintain financial stability.
Typically recorded on the profit and loss statement, business expenses such as rent, salaries and insurance are labeled as operating expenses and deducted from gross profit to arrive at the operating profit.
Unlike variable costs, fixed costs will not directly show in the cost of goods sold but are considered part of the broader business expenses under operating costs.
Managing fixed costs effectively is essential for maintaining business profitability. If fixed costs are high, a company must be prepared to generate consistent revenue to cover expenses and stay financially stable. By clearly understanding these costs, business owners can make informed and proactive decisions about scaling operations, entering new markets, or investing in major projects.
A well-planned approach also allows businesses to optimize pricing strategies, control overhead, and improve long-term sustainability. Keeping these expenses in check ensures profitability even during slow periods, reducing financial risk and supporting steady growth.
A good rule is to keep fixed costs reasonable compared to business revenue, ensuring they do not take up too large a portion of earnings. The ideal cost to revenue ratio varies by industry and business model, but businesses typically aim to keep fixed costs between 30% and 50% of total revenue.
Regularly reviewing these expenses helps prevent them from becoming disproportionately high relative to income. This process may involve renegotiating contracts, finding more efficient solutions, or taking steps to reduce expenses while maintaining operational effectiveness. Keeping fixed costs within a manageable range allows businesses to stay flexible and resilient against market fluctuations.
Effectively managing fixed costs starts with understanding accounting basics and implementing a structured system to track expenses. Fixed costs must be consistently monitored to ensure they align with revenue and business goals. By maintaining clear financial records, businesses can identify trends, control spending, and make informed budgeting decisions.
Using expense tracking software simplifies this process by automatically categorizing expenses, generating reports, and providing real-time insights. These tools can help businesses streamline accounting processes, reducing the risk of financial mismanagement. An expense manager can be another valuable asset — whether through automated software or a dedicated professional — to oversee costs and optimize financial efficiency.
For businesses with complex financial needs, hiring an accountant or bookkeeper can provide expert guidance. A professional can ensure compliance with tax regulations, analyze spending patterns, and offer strategies to improve financial health. Combining software solutions with professional expertise creates a robust system for managing fixed costs effectively, allowing businesses to focus proactively on growth and profitability.
Understanding and managing fixed costs is vital to running a successful business. Keeping these costs in check, leveraging expense tracking software, and working with professionals when needed can help a business stay stable and prepare for growth. To help make handling these finances easy, consider PayPal for Business. Additionally, explore our Business Resource Center for analytics insights, helpful financial strategies and practical solutions.