All You Need to Know about How to Calculate Fixed Cost

By Indeed Editorial Team

Updated May 31, 2022

Published August 17, 2021

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Every type of business has costs necessary to keep the business running. Costs typically fall into two categories, fixed costs and variable costs. Understanding the difference between these two types of costs can help you make smarter business decisions and plan for the future. In this article, we explain what fixed cost is, show you how to calculate fixed cost and average fixed cost, and give examples of fixed costs.

Related: The Differences Between A Bookkeeper And An Accountant: A Review

What is a fixed cost?

Fixed costs are expenses that remain the same regardless of how many goods you produce or sales you make. They are also referred to as overhead or indirect costs. Businesses differentiate between fixed costs and variable costs to keep track of their financial status. Production and sales levels directly affect variable costs. As production increases, so do variable costs. Knowing your business' fixed cost is important as you need to pay them regardless of whether the business made any income.

Fixed costs have several advantages to a business and a business owner, such as:

  • They remain constant throughout the production process unless undertaking major capital expenditure.

  • Calculating and tracking fixed cost is relatively easy, since it remains the same, even with a change in volume of goods produced or sold.

  • Per-unit fixed cost is likely to reduce as a business increase production levels.

  • Production costs remain constant for a range of output.

  • Fixed costs decrease the business net income for an accounting period, which reduces tax liability and increases business savings.

  • High fixed costs increase the barriers to entry for new entrants, reducing competition and increasing profitability.

Fixed costs may remain stable in the short term, but may change after a period of time, such as when the landlord increases rent payable or the employer changes the salaries paid to employees.

Related: 10 Skills Business Analysts Need For Workplace Success

How to calculate fixed costs

Knowing how to calculate fixed cost for your business is an important step in knowing how much it costs to run the business. For a start-up, knowing fixed cost allows the founders to know how much money they need to cover business expenses before the venture starts making money.

There are two methods of calculating your business fixed cost. The first method involves establishing three parameters, namely the cost of production, the variable cost per unit, and the number of units produced. Taking the total cost of production, subtract the cost of each unit multiplied by the units produced to get the total fixed cost. You can use this formula:

X=Y-(A×B)

Where:

  • X = fixed cost

  • Y = total cost of production

  • A = variable cost per unit

  • B = number of units produced.

The second method of calculating fixed cost is the tally method. Here are the steps to follow when calculating fixed cost using the tallying approach:

1. Outline your business costs

The first step includes outlining all your business expenses. You can do this by reviewing the receipts, bank statements, and petty cash register. Write or enter every expense and the respective cost in a spreadsheet or a similar sheet. If there are expenses payable annually, divide them by 12 to establish the monthly cost.

2. Identify the fixed costs

From your list of expenses, identify the costs that remain stable, regardless of output or sales. These are the fixed costs. Avoid including variable costs in the itemization of fixed costs. If in doubt, you can consult an expert, such as an accountant or an auditor.

3. Add the fixed costs

Once you have identified the fixed costs, take a calculator and add all of them together. The sum of the calculation represents your business' fixed cost. Every month, you need to have this sum to pay the listed expenses.

4. Track fixed costs

Fixed costs are not permanent and are subject to change from time to time. Track the fixed cost regularly to establish any changes and update your books accordingly. For instance, if you have a new employee or have moved to a more expensive premise, the fixed cost would change to reflect the new circumstances.

Related: A Guide To Entry-Level Accounting Interview Questions

What is the average fixed cost?

Average fixed cost is the cost it takes to produce a unit of product before considering the variable costs. Also called fixed cost per unit, the average cost per unit helps a business consider the fixed costs while pricing their products or services. To calculate the average fixed cost, you need to establish the total fixed cost and the number of units produced. Divide the total fixed cost by the number of units produced. The figure you get is the average fixed cost. You can use this formula:

Average fixed cost = Total fixed cost / Number of units produced

Related: Advanced Excel Skills: Definitions and Examples

Examples of fixed costs

Here are examples of typical fixed costs for a business:

Salaries and wages

For any business, paying its employees is an unavoidable expense. Salary and wages are the cost of paying employees for their services to the business. Salary and wages are fixed costs since they typically remain the same month to month. When the employer changes the pay structure, they adjust the fixed cost of their business to reflect the changes.

Business permits and licence

To operate as a legal entity, a business needs to obtain a permit or a license. The cost of permits and licenses is a fixed cost, as they typically remain stable regardless of how much the business produces or sells. Different businesses have unique licensing requirements, such as the validity period of the permit and the amount payable.

Rent

Rent is the cost of leasing a building or an office to conduct business operations. Lease agreements between you and a landlord often state the amount of rent payable. The rent is constant for a particular duration, such as one year, and is a fixed cost. The landlord may increase or decrease the rent depending on the business environment.

Loan payment and interest expense

If a business has a loan, the financiers stipulate the monthly instalment in the loan agreement. The monthly loan payment, which covers the loan principal and interest on the loan, is a fixed cost. This is because the business has an obligation to repay the agreed amount, regardless of the production output or sales volume.

Insurance premiums

A typical business takes several types of insurance, such as health insurance for its employees or property insurance to insure against events on its property. Insurance cost is a fixed cost since the business needs to pay the premium regardless of business output. You may pay the premiums monthly or annually, depending on the policy.

Utilities

While utility costs vary month to month, some utilities such as electricity bills are a fixed cost. This is because a business needs to pay a fixed minimum amount regardless of the production output. It is crucial to determine which utility costs may be fixed or variable.

Property taxes

Taxes charged by the government on business property are a fixed cost. Property taxes do not change frequently and businesses may expect to pay approximately the same amount of taxes in a given period, usually one year. Whenever the taxes increase or decrease, the business needs to update its books to reflect the changes.

Depreciation cost

A business asset loses its value with continued use. Depreciation is the method through which a business gradually captures the loss of value for its assets. Depreciation is considered a fixed cost as it does not change over the life of the asset.

Advertising cost

Advertising costs are a significant cost for any business as it allows it to make its product and services known to potential customers. Advertising includes costs such as print and electronic ads, marketing brochures, and catalogues. It is a fixed cost, as it is unaffected by production or sales volume. An increase in demand for a product or service may cause a change in the advertising cost.

Equipment leasing cost

Some businesses rely on leasing rather than owning crucial business equipment such as machines and vehicles. If the cost of leasing the equipment stays the same regardless of production levels, then it is a fixed cost. When the leasing cost varies month to month, depending on the output, the cost becomes a variable cost.

Amortization

Intangible assets' loss of value over time is called amortization. Amortization is a fixed cost since losing value does not depend on the output levels. For instance, if a business acquires a six-year patent, they can amortize the intangible asset within six years before it expires. The annual amortization cost is a fixed cost for the business.

Explore more articles