Fixed cost ( refers to the constant expenses ) and why it is important to your business

Every business, whether large or small, faces two types of costs: fixed costs and variable costs. Understanding this is not just an accounting matter but a key to keeping your business sustainable and growing.

Why Distinguish Between Fixed and Variable Costs

Effective cost management is fundamental to profit, but many entrepreneurs often fail to differentiate these two costs. As a result, they set inappropriate prices, plan unprofitable production, and ultimately lose customers to competitors who manage costs better.

Once you understand fixed and variable costs, you will be able to:

• Set prices that cover costs and generate profit
• Plan production intelligently based on market demand
• Make calculated investments in machinery or other assets
• Evaluate breakeven points and sales targets

Fixed Costs: Costs That Do Not Change

Fixed costs are expenses that a business must pay regularly, regardless of how many products are produced or sold. Even if your business stops production or temporarily closes, these costs still incur.

Think of Company X that rents a factory, pays staff salaries, and insurance premiums for assets and inventory. Whether they sell 1 or 1,000 units in a month, these costs remain the same.

Key Characteristics of Fixed Costs

1. Do Not Vary with Production Volume
Fixed costs are stable; whether your industry moves fast or slow, the amount paid per day remains constant.

2. Important for Financial Planning
Because they are predictable, managers can use fixed costs to prepare budgets and forecast revenues accurately.

3. Part of Cost per Unit
The fewer units produced, the higher the fixed cost per unit. For example, if rent is 100,000 THB/month and 100 units are sold, fixed cost per unit is 1,000 THB. If 1,000 units are sold, it drops to 100 THB per unit.

Examples of Fixed Costs in Business

Rent
Most businesses rent land, buildings, or storefronts. Rent paid monthly or annually remains the same until lease expiration.

Employee Salaries
Full-time staff such as managers, accountants, or administrative personnel receive the same salary each month, regardless of sales volume.

Insurance
Building, equipment, or vehicle insurance premiums are paid regularly, typically annually, to protect business assets.

Depreciation
When purchasing factories, machinery, or vehicles, depreciation is calculated monthly, regardless of how much the equipment is used.

Loan Interest
If your business borrows money, the interest payments are fixed and paid monthly as per the loan agreement.

Utilities (Water, Electricity) for Office
Basic utility costs are paid to keep the office operational. Additional usage beyond the baseline is considered variable.

Variable Costs: Costs That Fluctuate with Production

Variable costs are the opposite of fixed costs. Their value changes directly with the level of production or sales. The more you produce, the higher these costs; reducing production lowers them.

Referring back to Company X, if you want to produce more products, you need to buy more raw materials, often hire temporary labor, and pay for additional packaging and transportation. All these are variable costs.

Characteristics of Variable Costs

1. Increase or decrease with production
They are flexible and directly proportional to the quantity produced.

2. Provide management flexibility
Unlike fixed costs, variable costs can be controlled in the short term by adjusting production levels.

3. Affect unit cost of products
Analyzing variable costs allows businesses to calculate per-unit costs and set appropriate selling prices.

Examples of Variable Costs in Production

Raw materials and components
For clothing manufacturing, fabric, buttons, and zippers increase in cost as more garments are produced.

Direct labor
Workers involved in production, such as technicians or assemblers, incur additional wages if production volume increases.

Energy and water during manufacturing
Machines consume electricity and water; longer operation results in higher utility costs.

Packaging
Boxes, bags, labels, and other wrapping materials depend on the number of items produced.

Shipping and delivery
Transport costs rise with the volume of goods shipped.

Commissions
If sales staff or agents earn commissions based on sales volume, these are variable costs.

Comparing Fixed and Variable Costs

Clear differentiation helps companies make smarter investment decisions. For example, if direct labor costs are high, investing in automation machinery can convert variable costs into more stable fixed costs.

Analyzing Mixed Costs: The Key to Smarter Decisions

Mixed cost analysis combines understanding fixed and variable costs to get a complete picture of total costs. This approach helps managers see the big picture while managing details effectively.

Calculating Total Cost

Basic formula:
Total Cost = Fixed Cost + (Variable Cost per Unit × Number of Units)

For example, if fixed costs are 500,000 THB/month and variable cost per unit is 100 THB, producing 5,000 units results in:
Total Cost = 500,000 + (100 × 5,000) = 1,000,000 THB

Applying Mixed Cost Analysis in Decision-Making

1. Set appropriate prices
Knowing total costs helps determine selling prices that cover costs and generate profit.

2. Plan production efficiently
Understanding how costs behave allows resource allocation to minimize waste and maximize productivity.

3. Evaluate profitability
Knowing the breakeven point (where total revenue equals total costs) indicates how many units need to be sold to avoid losses.

4. Control costs
Tracking fixed and variable costs reveals inefficiencies and areas for improvement.

5. Assess market changes
If demand increases or decreases, cost analysis shows how sales volume impacts profitability.

Effective Cost Management Techniques

For Fixed Costs:

• Negotiate rent and contracts for better rates
• Consider leasing, purchasing, or short-term agreements
• Prioritize fixed expenses based on strategic importance
• Use technology to reduce initial investments

For Variable Costs:

• Negotiate bulk discounts with suppliers
• Improve production processes to reduce waste
• Monitor and control quality to minimize defective products
• Invest in technology that reduces labor costs

Why Fixed Costs Matter

Fixed costs and variable costs are like the imaginary land of business. Without understanding them, you walk in fog—uncertain when you’ll make a profit or incur losses.

Understanding these costs enables your business to:

• Price products appropriately, avoiding underpricing or overpricing
• Plan production aligned with market demand
• Make rational investments in assets and machinery
• Forecast revenues and control costs within budgets
• Grow steadily without risking losses from unknown costs

In today’s competitive environment, mastering cost management is essential for survival and growth.