Are you a business owner? We know it’s not easy. You might need help managing your expenses.

When it comes to balancing the books, understanding fixed and variable expenses is critical. But even the savviest business owners could use a hand defining terms and crunching the numbers. 

Here’s a breakdown of fixed and variable expenses: 

 

Fixed expenses

A fixed expense is any cost that does not fluctuate from month to month or year to year. Fixed expenses typically include:

• Advertising
  • Includes website hosting and media campaigns
• Insurance
  • Premiums paid to insurance carriers
• Interest rates
  • Only applicable to loans that have a fixed rate of interest
• Rent or lease costs
  • Monthly payments to a landlord or lender
• Property taxes
  • Taxes owed to a local government
• Salaries
  • Fixed payments to employees (regardless of hours worked)
• Utility bills*
  • Payments to providers of electricity, gas, phone, internet, sewer, and/or trash

 

*While utilities may fluctuate from month to month, they are considered fixed expenses because they usually require a minimum payment regardless of usage. 

 

Calculating total fixed costs

Your total fixed cost is exactly what it sounds like: the total sum of all your fixed expenses. 

To calculate your total fixed costs:

1. Look at your budget or financial statements.
2. Identify all your payments that stay the same on a month-to-month or year-to-year basis.
3. Add them all together.

 

Calculating average fixed costs

It’s important to know what percentage of your total fixed expenses are contributed to the products or services you produce. This is known as your average fixed cost (AFC), or your fixed cost per unit. 

To calculate your average fixed cost, divide your total fixed cost by the number of units you produce each month. 

For example:

• You produce 10,000 widgets per month.
• Your total fixed cost is $13,900.
• $13,900 divided by 10,000 equals $1.39.
• Your average fixed cost is $1.39 per widget.
• For every widget you sell, $1.39 goes to covering fixed expenses.

 

Calculating your AFC is important because it will help you determine the efficiency of your production efforts. In other words, if your AFC is equal to or more than the cost of your unit, you could be losing money. 

 

Variable expenses

A variable expense is any cost that fluctuates from month to month or year to year (usually due to the accessibility or volume of the goods for which you’re paying). Variable expenses typically include:

• Credit card fees
  • Payments made to banks or lenders
• Commissions
  • A percentage of sales paid to employees
• Delivery costs
  • Includes boxes, packaging, tape, stickers, labor, courier costs, and import/export fees
• Raw materials
  • Any input goods or inventory that you need to produce your product or service
• Piece-rate labor
  • Payments made to employees per unit built
• Production supplies
  • Includes everyday supplies such as computers, office furniture, ink, pens, paper, etc.

 

Calculating total variable costs

Your total fixed cost is simply the total sum of all your fixed expenses. 

To calculate your total fixed costs:

1. Look at your budget or financial statements.
2. Identify all your payments that vary on a month-to-month or year-to-year basis.
3. Add them all together.

Your variable expenses will increase or decrease depending on your production or sales volume. When your production goes up, your variable expense will go up. When your production goes down, your variable expense will go down. 

 

Calculating average variable costs

Your average variable cost, or variable cost per unit, represents the amount of money you pay for every product you produce. 

To calculate your variable cost per unit, divide your total variable cost by the number of units you produce each month. 

For example:

• You produce 10,000 widgets per month.
• Your total variable cost is $15,400.
• $15,400 divided by 10,000 = $1.54.
• Your average variable cost is $1.54 per widget.
• For every widget you sell, $1.54 goes to covering variable expenses.

 

Measuring fixed expenses against variable expenses

Understanding your fixed expenses and variable expenses can help you perform your break-even analysis. This is used to determine the number of units you must produce to cover your total costs. At this point, there is no gain or loss for your business. 

 

Calculating break-even analysis

To calculate your break-even analysis, use this formula:

Fixed Costs / (Sales Price per Unit – Variable Cost per Unit) = Break-even Point in Units

For example, let’s use the data provided in the examples above:

Fixed costs = $13,900
Variable cost per unit = $1.54

To complete the formula, we need a sale price for each widget. Let’s say it’s $5. We can complete the following formula:

$13,900 / ($5 – $1.54)
$13,900 / ($3.46)
= 4,017

To break even, you would need to sell 4,017 widgets per month.

 

Contact us!

We understand that calculating costs can be difficult. Fortunately, we’re here to help! If you need help managing your business accounts, contact us today.