Examples of fixed costs
/What is a Fixed Cost?
A fixed cost is a cost that does not change over the short-term, even if a business experiences changes in its sales volume or other activity levels. This type of cost tends to instead be associated with a period of time, such as a rent payment in exchange for a month of occupancy, or a salary payment in exchange for two weeks of services by an employee. It is of some importance to understand the extent and nature of the fixed costs in a business, since a high fixed-cost level requires a business to maintain a high revenue level in order to avoid generating losses. Conversely, a business with low fixed costs can continue to operate profitably even when its sales are low.
Examples of Fixed Costs
Many of the costs incurred by a business are fixed costs. Here are several examples:
Amortization. This is the gradual charging to expense of the cost of an intangible asset (such as a purchased patent) over the useful life of the asset.
Depreciation. This is the gradual charging to expense of the cost of a tangible asset (such as production equipment) over the useful life of the asset.
Insurance. This is a periodic charge under an insurance contract.
Interest expense. This is the cost of funds loaned to a business by a lender. This is only a fixed cost if a fixed interest rate was incorporated into the loan agreement.
Licenses and permits. A business will likely have to pay the same amount for a license or permit, irrespective of its sales volume, and will have to keep doing so for as long as it remains in business.
Property taxes. This is a tax charged to a business by the local government, which is based on the cost of its assets.
Rent. This is a periodic charge for the use of real estate owned by a landlord.
Salaries. This is a fixed compensation amount paid to employees, irrespective of their hours worked.
Utilities. This is the cost of electricity, gas, phones, and so forth. This cost has a variable element, but is largely fixed.
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What is a Variable Cost?
The reverse of fixed costs are variable costs, which vary with changes in the activity level of a business. Examples of variable costs are direct materials, piece rate labor, and commissions. In the short-term, there tend to be far fewer types of variable costs than fixed costs.
Over the long term, few costs can be considered fixed. For example, a 10-year property lease can be considered a fixed cost over a nine-year period, but is a variable cost if the decision period extends past 10 years.
Impact of Fixed Costs on Profit
A business is sometimes deliberately structured to have a higher proportion of fixed costs than variable costs, so that it generates more profit per unit produced. Of course, this concept only generates outsized profits after all fixed costs for a period have been offset by sales. For example, a software development company has a fixed cost requirement of $500,000 per month and essentially no cost per unit sold, so revenues of $400,000 per month will generate a loss of $100,000, but revenues of $600,000 will generate a profit of $100,000. See the cost-volume-profit analysis for more information.
FAQs
Is Rent Considered a Fixed Cost?
Rent is considered a fixed cost because it remains constant regardless of the company’s level of production or sales. Businesses must pay rent each period, even if no goods are produced or services rendered, making it a predictable and recurring expense.