The total expenses incurred by any business are divided into two main categories which are fixed and variable costs. They incurred by businesses in order to continue producing goods and services for sale. They provide a clear picture of your overall expenses. They may be fixed which do not change or variable that can be changed. It’s important to know them while working on costs of production. Let’s take a look of them.
A fixed cost is independent of production. It does not change with the volume of production a company produces. It remains constant and must be paid even if no goods are produced. For example, a company pay rent on monthly basis for its factory for producing blocks, if company does not produce blocks for a month, it would still have to pay the factory rent. Fixed costs are also known as overhead or indirect cost. They are generally weekly, monthly or annual expenses. Examples of fixed costs are:
- Monthly rental payments for factory, office, warehouse or other premises.
- Salaries and wages of employees.
- Payment for insurance.
- Depreciation of building and machinery.
- Payment of interests.
- Vehicle leasing and maintenance.
- Research and development.
- Legal expenses.
A variable cost is dependent of production. As volume of production increases, the variable cost also increases and vice versa. The variable cost varies with the volume of production. For example, a company produces bottles, while per bottle cost is Rs. 3. If the company, produces 1000 bottles, its variable cost will be Rs. 3000. However, if the company does not produce any bottle, it will not have to pay any variable cost for the production of bottle. Variable costs are also known as prime cost or direct cost. Examples are following:
- Direct material used for production.
- Direct labor used for production.
- Delivery charges.
- Fuel expenses.
- Utilities expenses that increase with business activities such as electricity, gas or water usage.
Understanding the fixed and variable cost will help you to build an effective budget and cash flow forecast for your business. Additionally, understanding these costs will allow you to manage your business effectively.