FIXED COSTS: When you’re in business there are certain things you have to pay no matter what happens.You have to pay for your building or office space, your equipment and machinery, your insurance, etc. These costs come every month whether or not you sell or produce anything. Like death and taxes in your personal life, they are going to happen! To stay in business you have to understand and take care of these basics. So Fixed Costs happen every month.
FIXED COST: A cost that does not change with an increase or decrease in the amount of goods or services produced. Fixed costs are expenses that have to be paid by a company, independent of any business activity. (Source: Investopedia.com)
Some of the accounting types will try to break business into only two costing categories: Fixed and then Variable Costs (everything else). Personally, when I break down a business’s finances I use a three category approach and add Mixed Costs to the analysis. Mixed Costs in speaking business terms do not fit either category perfectly. Things like Salaries (payroll) or utilities are often included as Fixed Costs, but in reality aren’t. As production or sales increase a company’s payroll costs will increase so it should be variable, right? But I know very few businesses that have employees, especially administrative positions, who will go without a paycheck just because the company didn’t sell anything this month, so now it is a fixed cost, right? The answers is it is both, fixed and variable so it is mixed. Utilities are another expense category that is mixed. The water and power companies are going to send a bill every month regardless. It may vary in amount and increase with increased production, but it is still a fixed cost in that it happens every month regardless. Then it is variable in the fact that the amount of the payment changes. So again, it really falls into a mixed cost category.
In an earlier Speaking Business I wrote about one tool a business can use to get and understanding of how Fixed Costs and Mixed Costs impacts their bottom-line. That tool was an ABC Analysis, Activity Based Costing, and how you can use this technique to account for fixed cost in your day-to-day activity. The ABC analysis also accounts for the mixed and variable costs as well by assigning a hard-dollar amount to every activity in the company. At the end of the day, if a business doesn’t understand their Fixed Costs as well as the Mixed and Variable Costs they will not be in business long.