What Is Total Fixed Cost? (With Examples and Calculations)
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Business owners regularly conduct business planning, with the budget and costs among the main discussion points. Cost refers to the expenses that a business incurs from the manufacturing and operations of its goods and services, and other fixed or variable process expenses. Learning about fixed costs may help you with your cost structure management and business analysis. In this article, we define what a total fixed cost is, review its types, describe variable costs, discuss how to calculate fixed costs, and provide examples.
What is total fixed cost?
The term total fixed cost refers to a business cost that doesn't change or depend on the increases, decreases, or stoppage of the goods and services that a company produces and sells. It exists even when production is zero or when sales volume changes over time. Fixed costs keep the business operations running and businesses often refer to them as overhead expenses. These are in the company's total cost structure. An organization's cost analysts evaluate these expenses because they directly influence the business' total profitability.
In some cases, fixed costs result from established contract agreements or schedules. This usually involves the base cost of operating a business, which includes salaries and rent payments. Because these values remain unchanged over time, the company works harder to produce and sell their products to generate more revenue or to at least break even with the payments and profit. Cost analysts account for the long-term or short-term liability fixed cost on the balance sheet and cash flow statement of the company.
Types of fixed costs
Understanding fixed costs may help a company with high fixed cost levels strategize on how to maintain and achieve higher revenue to avoid generating losses. Alternatively, if the fixed costs of a business is minimal, it may survive even with low sales. Fixed costs may include the following:
Depreciation: This term refers to the accounting method that finance experts, such as accountants, use to allocate the cost of a tangible or physical asset, such as production equipment over its useful life. This represents the used value of an asset, allowing companies to earn revenue through these assets by paying for them over a particular timeline.
Amortization: This refers to the accounting process of lowering the book value of an intangible asset over a set period of time. Businesses amortize their intangibles over time to tie the cost of their assets to the revenue that they generate from these.
Insurance: An insurance contract requires a periodic fixed premium rate charge. This may include health insurance for employees and property insurance.
Salary: The compensation amount the company pays to employees remains unchanged, irrespective of activity levels and the number of working hours. Employees get the same amount regardless of how the business is doing.
Utilities: This includes electricity, water, phone, and internet bills. The value may fluctuate over time but remain unaffected by business operations.
Property tax: This refers to the tax the local government charges to a business depending on the value of its total assets. A building manager may also charge property tax for their office spaces.
Rent: This refers to the charges a landlord collects for the use of a real estate property or building. These costs tend to be stable for businesses that are renting office spaces serving as headquarters or employee workspaces.
Warehouse space lease: Businesses pay for warehouses the same way they pay for office spaces. The cost remains unchanged and stable unless the business runs out of storage space and capacity, in which case it may be necessary to rent another warehouse space, resulting in additional costs.
What is variable cost?
Variable costs depend on the business output. These are similar to fixed costs because they also fall under the total cost structure of the company that may influence total profitability. Variable costs differ from fixed costs because they change depending on how much a company produces and sells. They increase and decrease with the company's production volume. When the production volume goes up, the variable cost increases, and when it goes down, the cost decreases.
Variable costs may impact the growth and profitability of a business by acting as an indicator to whether it may be beneficial for the business to expand. When companies increase their production to meet demand, their variable costs also increase. In some cases, the rate of increase of the variable costs may exceed the profit the company is generating, making expansion an inappropriate move for the business. Understanding this concept may help businesses thrive and strategize. Some examples of variable costs include:
Commissions: Companies in the field of customer service or sales may provide commissions or incentives to their sales agents if they manage to sell products or services. Sometimes, a company only gives out commissions when their salespeople achieve their quotas, making this a variable cost for the company.
Raw materials: The cost a company spends on raw materials that they use in producing goods is a variable cost. This includes other production supplies, the consumption of which depends on the frequency and amount of equipment usage, such as machinery oil.
Packaging: Accountants record packaging materials as variable costs because these increase as sales increase. Producing more goods often means more packaging materials are necessary for processing.
Staff wage: The salary of employees working per hour falls under the variable cost category. Their pay may vary if the company requires them to work more or fewer hours, depending on the status and volume of production.
Shipping fees: A business may incur shipping or freight costs when it sells a product that requires shipping. Shipping may not apply to all products, so this cost falls under the variable cost category.
How to compute fixed costs
Efficient analysis of a company's cost structure helps them manage the impact of both fixed and variable costs. Being able to manage fixed costs allows them to maximize their revenue. Here are the steps on how to calculate the fixed cost:
1. Identify all costs
This may include building rent, website hosting cost, insurance, and other overhead and variable costs. You can include all monthly recurring bills and any contracts with yearly payment terms, such as insurance and loan interests. It's important to consider all business expenditures on the list and repeat expenses that the business may incur from any equipment or machine depreciation.
2. Classify the costs in the list as fixed or variable
Study your list and ensure the inclusion of all relevant business costs. You can then proceed with classifying which costs fall under fixed costs and which expenses are variable. It's important to make a separate list of the fixed costs for further calculation.
3. Convert the fixed cost items to the desired units
This step entails checking how you declared the values in the list of fixed costs. You may convert all yearly expenses to monthly or all monthly bills to yearly. This depends on how you want to record and evaluate the costs.
4. Add up all the fixed costs
After converting all values to the same units, you may add them together to obtain the total fixed cost. You may manipulate the data to obtain either yearly or monthly fixed costs. Using the result, you may now evaluate and strategize how to increase company revenue.
Example calculations for fixed costs
Here are some examples of fixed cost calculations that may help you understand the concept more:
Example of calculating fixed monthly costs
Below is an example illustrating how to calculate monthly costs:
Exy Furniture Shop conducts its annual budget planning during the last month of the year. In preparation, their accounting analyst listed all company costs to calculate the overhead for reporting during the budget planning meeting.
The analyst started by listing all their fixed and variable costs:
The analyst then separated the fixed costs from the variable costs. The fixed costs include the following:
Office rent: $2,000 monthly
Salaries: $150,000 monthly
Utilities: $800 monthly
Insurance: $1,728 annually
The company requires that they report costs by month, so the analyst converts the insurance figure by dividing $1,728 by 12 to find $144 per month. The accounting analyst added up all the fixed costs and came up with Exy Furniture Shop's monthly total fixed cost of $152,944.
Example of calculating fixed business costs
Here's another example of calculating fixed business costs:
HighStocks Trading Company aims to expand their business by next year. To do this, they want to study their yearly company expenditures to check if the expansion may benefit the business. They start by creating a list of all their fixed and variable costs and find the following:
They proceed to separate the fixed from variable costs using the yearly values, resulting in this list:
Warehouse rent: $18,000
Property tax: $15,000
They add together all the individual fixed costs and came up with $1,243,200 and can use this data in their feasibility study.
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