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Overview of Fixed Costs
Definition of
Fixed Costs
What are Fixed Costs? Fixed Costs are business expenses that remain constant in total amount regardless of the level of production or sales volume, within a specific period and relevant range of activity. Unlike variable costs, they do not fluctuate directly with output. Common examples include monthly rent payments, base salaries for administrative staff, annual insurance premiums, property taxes, and straight-line depreciation. Understanding fixed costs is crucial for determining a company's break-even point and overall cost structure.
Activities Related to
Fixed Costs
Here is a list of Fixed Costs related activities:Â
Budgeting annual or monthly expenses (like rent, salaries, insurance), Calculating the break-even point using CVP analysis, Analyzing the company's operating leverage, Making long-term capacity decisions (e.g., leasing larger facilities), Allocating overhead costs (as many fixed costs are overhead), Negotiating leases and salary agreements, and Managing period costs.
Identifying and managing fixed costs are key components of financial planning and control.
The Importance of
Fixed Costs
For small business owners, understanding Fixed Costs is essential because they represent the baseline level of expenditure the business must cover each period, regardless of how much is sold. Knowing these costs is critical for setting prices, determining the break-even sales volume, and effective budgeting. High fixed costs mean the business needs to achieve a higher sales level to become profitable, increasing operating risk (leverage). Conversely, controlling fixed costs can improve profitability and financial flexibility. Accurate identification and tracking of fixed costs through diligent bookkeeping are vital for financial stability and informed strategic decisions.
Key Aspects of
Fixed Costs
Constant in Total
The total amount of fixed cost remains the same over a period, irrespective of changes in activity level within the relevant range.
Variable Per Unit
While constant in total, the fixed cost *per unit* of activity decreases as the activity level increases (the same total cost is spread over more units).
Time-Related
Fixed costs are often associated with the passage of time (e.g., monthly rent, annual salaries) rather than the volume of production or sales. They are typically considered period costs.
Concepts Related to
Fixed Costs
Fixed Costs are a fundamental concept in Cost Behavior analysis, contrasting directly with Variable Costs and forming a component of Mixed Costs. They are crucial inputs for Cost-Volume-Profit (CVP) Analysis, particularly in calculating the break-even point. Fixed costs often overlap with Overhead costs and are typically treated as Period Costs, meaning they are expensed in the period they are incurred rather than being attached to products. Understanding the relevant range is important, as fixed costs might change if activity levels shift dramatically (e.g., needing a second factory).
Fixed Costs
in Action:
The Adventures of Coco and Cami
Follow the entrepreneurial journeys of Coco, who's opening a sandwich shop, and Cami, starting a coffee shop, as they figure out which expenses stay the same each month, like their rent.
Watch as Professor A explains Fixed Costs to Coco and Cami, highlighting how these stable expenses form the baseline for their monthly budget planning.