Understanding Fixed Costs for Your Business
Whatever type of business you operate you are going to have to pay a certain amount of your profits each month in fixed costs. It is important that business owners develop a good knowledge of their fixed costs so they can more accurately budget for them.
If you are not fully aware of your fixed costs or how to factor them into your calculations, then keep reading this article. We will take a brief look at what fixed costs are, what variable costs are, give you examples of both and show you how to include your fixed costs when calculating your profit margins.
What are fixed costs?
Fixed costs are recurring costs that a business has to pay regardless of how much profit it made or even whether or not it was trading during the time the costs were incurred. Fixed costs are usually set at a stable rate, so they don’t fluctuate over the short to medium term. Your fixed costs act as the baseline overheads from which you can calculate your profit margins, judge your possible tax liabilities and project your future growth potential.
Some examples of common fixed costs include:
- The monthly rent on your place of business
- Electricity and gas costs
- Employee wages
- Water rates
- Telephone line rental
- Council rates
- Broadband costs
- Vehicle leasing costs
- Accounting and legal costs
- Marketing and advertising budgets
- Insurance premiums
What are variable costs?
While a business has fixed costs, it will also incur variable costs. Variable costs are defined as expenses incurred from increases in sales or from manufacturing products. As the name suggests, variable costs can go up or down depending on the amount of activity your business is generating.
Some examples of common variable costs are:
- Salaries paid to staff based on piecemeal work
- Staff bonuses and sales commissions
- The cost of producing or selling goods
- Materials required to produce goods
- Business-related travel, entertainment and hotel expenses
- Transportation or delivery costs
If a business requires legal assistance, then the associated legal fees would be seen as variable costs since they may change over a short period of time. For example, if a business is sued in court by an employee over a medical matter such as an injury and loses the case, then as the defendant the business will need to pay damages to the claimant and fees to the lawyers. Some of these costs may be recoverable via an insurance claim. These types of claims are why a business pays the fixed costs of insurance premiums.
It should be noted that some fixed costs can actually transform into variable costs over time. An example of this would be the lease on a business premises. During the duration of the lease, the business will have to pay a set rental price each month. Thus, during this time the lease can be categorised as a fixed cost. Once the term of the lease has expired, it is up for renewal and can be changed, thus transforming into a variable cost until a settlement is reached and the lease becomes a fixed cost once again. As a general rule, there are far fewer variable costs involved in running a business than there are fixed costs.
How to factor fixed costs into your calculations
Both fixed and variable costs need to be taken not account when predicting the profitability of a business. The point where your business starts to accrue profits is known as the ‘break-even point’.
The protocol involved in finding your break-even point involves taking the amount of income generated from sales from your business and then subtracting your variable and fixed costs from this amount. If you arrive at zero at this stage, you have broken even. This means your business has incurred no losses but has also generated no profits. When sales amounts go past the break-even point, they can then be counted as profit.
When deciding on what price to place on your goods or services, you must first consider the variable costs involved in producing the good or service in question. The price must be higher than this amount. Each sale will then produce income that will be used to pay your fixed costs. If you generate enough sales, then you will be able to go past the break-even point and start to make profits.
Both fixed costs and variable costs need to be closely tracked and monitored. However, it can be difficult for busy business owners to keep accurate records of all their outgoing business expenses. Mooncard can help you keep your accounts in order.
Using the Mooncard payment system you can track your expenses. It’s great for a business that is just starting or can be used for an established enterprise. Every time a purchase is made for your business, the purchaser takes a digital photo of the receipt. This data is used to automatically generate an expense report using your pre-recorded details. The expense report is then forwarded to your accounting department. All data is kept digitally so it can be easily accessed anytime you or HMRC wish.
Book online to try a free, no-obligation Mooncard demonstration.