Fixed costs vs variable costs: Entrepreneurs need to understand this difference

Do small business owners often encounter problems? These many issues stem from a common source – a lack of understanding of their own cost structure. This article will help you understand the meaning and importance of Fixed Cost (Fixed Cost) and Variable Cost (Variable Cost), which are fundamental to effective financial management.

What is a (Fixed Cost)?

Fixed costs are expenses that do not change regardless of whether your business earns a lot or a little. Whether you produce 1 item or 1,000 items, these costs remain in the same position. Like a mountain that stays still, rain or clouds passing by do not affect it.

Why are fixed costs important for financial planning?

Fixed costs are burdens you carry every day, every hour, even if cash flow isn’t coming in. Knowing about fixed costs is crucial because it allows you to set selling prices accurately to cover all costs and still make a profit. Proper management of fixed costs will make your business financially stable in the long run.

What does a fixed cost include?

1. Rent

Whether you use an office or a factory, rent must be paid monthly without exception. This is a classic fixed cost. It does not depend on whether you sell products or not.

2. Salaries of permanent staff

Full-time employees working for you daily receive a fixed salary, regardless of sales performance. This remains a fixed cost.

3. Business insurance

Asset insurance or liability insurance – paid regularly to protect the business from risks.

4. Depreciation of assets

Machines, equipment, buildings – all depreciate over time, and this depreciation is recorded as a cost in full.

5. Loan interest

If you borrow money, interest must be paid regularly, whether the business faces problems or not.

Variable Cost (Variable Cost) – The other half of the story

Variable costs are the opposite of fixed costs. They change according to production or sales. The more you produce, the higher these costs; the less you produce, the lower they are.

Key characteristics of variable costs

Variable costs increase or decrease proportionally with the production volume. This flexibility allows the business to control these costs to some extent. You can reduce these costs if demand decreases.

What are some variable costs?

1. Raw materials and primary supplies

If you produce baked goods, flour, sugar, eggs – all increase as you increase production.

2. Direct labor

Workers paid by the hour or per unit produced – the more you produce, the higher the wages.

3. Packaging and shipping

Cost of packaging and shipping boxes – these costs increase with the number of products sold.

4. Energy costs (related to production)

Electricity and water used in the production process increase as production volume increases.

5. Sales commissions

Distributors or sales teams earning a commission based on sales – higher sales mean higher commissions.

Clear differences between fixed costs and variable costs

Analyzing total costs for better decision-making

How to calculate total costs

Total Cost = Fixed Cost + (Variable Cost per unit × Number of units produced)

Imagine your bakery business:

• Fixed costs: Rent 10,000 THB + Employee salaries 20,000 THB = 30,000 THB/month
• Variable cost per bread: 5 THB (flour, sugar, eggs)
• If you produce 2,000 breads per month: Total variable cost = 10,000 THB
• Total cost = 30,000 + 10,000 = 40,000 THB

Why is knowing the total cost important?

1. Pricing – Divide total cost by the number of products to find the cost per unit, then add a margin.
2. Production planning – Know how many units you need to sell to break even (Break-even point).
3. Investment decisions – Understand whether increasing machinery (fixed costs) will sufficiently reduce variable costs.
4. Cost control – If costs are high, identify ways to reduce fixed costs or variable costs.

Summary: Understanding fixed costs and variable costs opens the door to smarter management

Whether small or large, understanding fixed costs and variable costs is the foundation of financial decision-making. Recognizing these costs helps you to:

• Set prices accurately – Avoid overpricing or underpricing leading to losses
• Plan for financial crises – Understand expenses that must be paid even without income
• Make rational investment decisions – When to increase fixed costs to reduce variable costs
• Adapt to market changes – Know what to do when the market declines to sustain your business

Therefore, if you have not yet analyzed your own business costs, now is the best time to start.