Fixed costs are outlays incurred by a business that are maintained, regardless of changes in sales, operations or profitability. These costs are essential to a company’s operations, and typically remain unchanged until the costs are adjusted intentionally, or through major strategic decisions. Fixed costs are recurring expenses that are necessary to the functioning of a business, and they aid a company with budgeting and forecasting.
Overview
Fixed costs are expenses that a company assumes as a given, and are likely to remain consistent regardless of changes to revenue or costs of input resources, like materials or labor. They are the costs that are in place and essential for the company’s operations. Fixed costs are the costs that remain the same over a given period of time and are easy to forecast and budget for.
Generally, these costs come in two forms: apparatus costs and composition costs. Apparatus costs are fixed expenses that are associated with physical assets or equipment used to facilitate the operation of the business. This could be any hardware, machinery, land, or buildings used in manufacturing products or services. While apparatus costs are generally large, once-off investments, they may also include other expenses like install fees or other service costs to set up and maintain the physical resources. Composition costs are the costs that come with day-to-day operations, such as rent, phone bills, wages, and other recurring expenses.
Fixed costs should not be confused with variable costs, which tend to fluctuate in response to changes in production, labor, and other input factors. Variable costs may include materials needed to manufacture products, or fees associated with adjusting and maintaining production levels.
Key Considerations
Fixed costs are essential outgoings and should be considered with a thorough review and assessment of a company’s operations:
• Monthly fees, like rent, phone, internet, wages, etc.
• One-off investments, like building purchasing or equipment costs.
• Utility bills for heating, cooling, and water supply.
• Insurance expenses, including any worker-related compensation covers.
• Legal expenses, like contractor or licensing fees.
Fixed costs are typically necessary regardless of changes to sales or input costs, and should be assessed regularly within the framework of an overall financial model. Changes to fixed costs can be facilitated by strategic decisions and restructurings, if a company decides that overall fixed costs should be reduced in order to cut expenses and increase profitability.
Real-World Example
An example of a fixed cost may be the monthly rent for a business premises. Even if a business performs exceedingly well and sales increase, they would still need to pay this rent cost for using the premises. However, in the case of a total restructuring or new business venture, a company may decide to invest in new premises as part of a more significant change in operations, therefore reducing the rent expense and resulting in a lower fixed cost down the line.
Conclusion
Fixed costs are regular and necessary expenses that remain constant regardless of production or sales levels. These costs are important to have in place and should be managed and staffed appropriately to suit a company’s operations and budget requirements. Fixed costs aid financial forecasting and budgeting, and through strategic decisions, changes can be made if a company desires to reduce the overall fixed costs.
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