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What Is the Difference Between Fixed and Variable Cost?

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  • Written By: K. K. Lowen
  • Edited By: Allegra J. Lingo
  • Last Modified Date: 05 July 2014
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Fixed and variable cost comprise a business' or organization’s total cost. A business or organization can label most costs as either fixed costs or variable costs, including staff salaries, supplies, rent, and any other purchases or bills. Costs that do not change based on the amount of service or the number of goods provided are fixed costs, while variable cost may increase or decrease depending on the amount of service or goods produced. Both types of cost are necessary considerations when performing differential cost analysis.

Costs such as rent and staff salaries are fixed costs because they do not change based on the amount of service or goods produced. For example, the rent must be paid for a leased storefront regardless of how many sales the business has. Similarly, a factory worker who receives a salary or hourly wage does not earn more or less money based on the amount of goods produced by the factory. Rent and salaries are two common fixed costs, but other costs, such as depreciation, also fit into the category.

Variable costs usually include supplies necessary for operation, items purchased for resale, and other items of cost that vary depending on the number of sales, amount of service provided, or the quantity of goods produced. Food in a restaurant, for example, is a variable cost because the amount spent on ingredients relates to how much food the restaurant sells to customers. Items such as take-out containers are variable costs as well.

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A cost may sometimes be difficult to categorize, such as electricity. If a factory’s output increases, it may use more electricity. The business can expect to pay minimum amount regardless of the number of goods produced, but the amount could increase based on production like a variable cost. Businesses sometimes use the term mixed costs when difficulties arise in differentiating between fixed and variable cost. Performing some types of financial analysis may require a business to put a mixed cost into either the fixed or variable category.

The distinction between fixed and variable costs is important for business owners. Differential cost analysis requires costs to be categorized and treated differently for individual financial decisions. These categories are used for a number of purposes during differential cost analysis, including profitability analysis and marginal pricing. Break-even point calculations are also a very common use for fixed and variable cost because companies must find the break-even point to determine the amount of service they must provide to prevent losing money.

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irontoenail
Post 3

@indigomoth - That's assuming that people will be able to make enough sales to overcome the initial fixed costs. That's why it's so important to take both kinds of cost into account, in any business.

A lot of small businesses ignore the fixed costs by getting a loan and then don't realize that those costs are still basically there. Variable costs seem easy to cover because they only exist if you're making a sale (although that's not really true either).

indigomoth
Post 2

@bythewell - That sounds like what they still do to musicians at the moment. There have actually been cases of best selling bands owing money to their record company, because of "creative accounting" that made the variable costs of producing albums seem much larger than they actually are.

I can see why self-publishing would be so appealing, particularly in a digital world. Once you've dealt with the initial fixed costs of making the book look good, there are essentially no variable costs because it doesn't cost you anything for people to download your book or music.

bythewell
Post 1

I've had to think about this a bit recently, because I'm trying to be a successful published author and one of the things that you have to worry about (if you don't have an agent) is the publishing contract.

There have been some terrible contracts going out recently and I've been trying to get my head around them so that I don't fall prey. The change that has everyone up in arms seems to be that the publisher in question is saying that they will give a larger percentage of sales to the author, but only after variable and fixed costs of production and marketing have been taken out.

Traditionally the publisher is supposed to handle those costs, and many of the larger ones actually own the companies that take care of them, like printing presses.

And fixed costs are less of an issue, because technically, the sales of the book were always going to pay for those. Once they are paid for at the start, that's it. But variable costs are so easily inflated and they will always be there. An author on a contract like this could end up with nothing at all.

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