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Fixed Cost vs Variable Cost: What’s the Difference?

Understanding Variable Cost vs. Fixed Cost

A variable expense, on the other hand, may change due to various factors – which means you can’t always predict exactly what it will cost. But it’s also important to understand that increasing production can also help you lower your costs, resulting in even greater profits. So in keeping with our bakery example, as sales steadily rise, each cake will eventually cost less to produce. Variable costs for a furniture maker could include raw materials, wages, packaging, and gas for delivery trucks.

What is a fixed cost and variable cost?

A fixed cost is a cost that a business must undertake regardless of the number of units they sell. In fact, in most cases, fixed costs are required before production can even begin. In contrast, variable costs change directly with the amount of production. Variable costs go up as the number of units produce rises, and decreases if production lessens.

You can calculate the variable cost for a product by dividing the total variable expenses by the number of units for sale. To determine the fixed cost per unit, divide the total fixed cost by the number of units for sale. As a small business owner, it is vital to track and understand how the various costs change with the changes in the volume and output levels. The breakdown of these expenses determines the price level of the services and assists in many other aspects of the overall business strategy. These costs are also the primary ingredients to various costing methods employed by businesses including job order costing, activity-based costing and process costing.

When purchasing raw materials

While this might increase the interest rate, it can lower your costs until you are in a more financially comfortable place. Your cost structure—essentially, your ratio of fixed to variable costs—is a key element in the resilience of your business. Proper distribution of fixed versus variable costs is fundamental to being able to survive the tough times and capitalize on opportunities.

Over the course of a year, the bakery would need to sell 1,887 cakes—about 36 cakes per week—to break even. Anything more than that would allow the company to be profitable. For Orange Bus founders Julian Leighton and Mike Parker, leaving the business was always the plan. Industry Trends Industry deep dives, macro trends, and profiles of fascinating businesses and founders.

Understanding variable costs

These costs will increase as production ramps up during certain times of the year. A restaurant owner will need a brick-and-mortar space in order to do business, so rent and insurance will be among their most notable fixed costs. Even if they opt for a delivery-only model, they still have to prepare food Understanding Variable Cost vs. Fixed Cost in a commercial kitchen that meets all health and safety standards. A traditional restaurant will also need seating space, furniture, and access to parking or public transportation. Location will be a major factor in what type of clientele the restaurant can attract and how expensive the rent will be.

Understanding Variable Cost vs. Fixed Cost

For instance, increasing output using the same amount of material can dramatically cut down costs, provided the quality of goods isn’t impacted. Developing a new production process can help cut down on variable costs, which may include adopting new or improved technological processes or machinery.

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