What’s the difference between Fixed Cost and Variable Cost?

Wondering the difference between fixed cost, variable cost and total fixed cost? Here’s a quick overview on the different cost types.

One of your responsibilities as a business owner is to understand accounting terminology. It might seem potentially unnecessary, particularly when you have an accountant.

However, when you can distinguish between fixed costs, variable costs, and total costs, you develop better financial insights. Such understanding helps you set prices appropriately if you’re to run at a profit. This, in turn, contributes to improved cash flow reports. Additionally, the concepts are exciting and easy to grasp
when you see how they apply to your business.

All costs sound similar, but there is a significant difference between fixed cost, variable cost and total cost. The primary distinction is that fixed costs don’t account for the total number of services or goods, while total costs and variable costs depend mainly on that number.

Wondering what the differences between these three costs are? Below is a review of each cost type.

Fixed Costs

Fixed costs are also called fixed overheads or expenses. Such expenses remain the same from one month to another. They don’t change with your sales or production volume. Even when your organization is not making sales, you have to pay such expenses.

The costs are included in your balance sheet and income statement. They are predictable expenses, and you know how much you need to stay in business. Examples are rent, insurance, equipment leases, depreciation, management salaries and interest on loans.

Variable Costs

Variable costs or variable expenses change from one period to the next. The total variable costs refer to the money you spend on the production and sale of your goods or services. They include raw material and labour costs.

As the volume of production and sales increases, the variable costs also increase. They are also connected to your revenue, as the more you sell, the more income you earn. Examples of variable costs include costs for raw materials, packaging, labelling, shipping, overtime salaries, commission, and taxes.

Total Cost

They comprise both total variable and total fixed costs. Total fixed costs are the sum of consistent fixed expenses a business has to pay. For example, when your company leases offices for $15,000 a month, rent of machinery $5,000 monthly, and a $1,000 utility bill, the total fixed costs will be $21,000.

For variable costs, when a company produces 4,000 units at $20 per unit and pays employees $6,000 overtime to meet the increase, the total variable costs will be 86,000. Consequently, the total costs will combine the fixed cost of $21,000 and variable costs of $86,000 to achieve $107,000. Total cost is a value the business must watch closely to ensure it remains profitable and thrives in the long run.

If you’re looking for an experienced accounting partner who will help take your business to the next level, contact us for more information. Visit our blog for more articles, news and updates about small business accounting, tax planning, CRA audits and bookkeeping.