Fixed Costs vs. Variable Costs
Businesses often look at the costs of a product or service and compare it to the amount they can charge for it. They may then conclude that if they could raise their price, they would be able to make more money. This is a common mistake, as it does not consider how much of their costs are fixed and how much is variable. Variable costs are the ones that change with the quantity of a product or service sold. Fixed costs are the ones that do not change. Here Dr. Jordan Sudberg discusses the difference between fixed and variable costs.
1. Fixed Costs
A fixed cost is a cost that does not change regardless of how much product or service is sold. An example of a fixed cost would be the rent on the store you work in or the sales tax that your company pays. These costs do not change no matter what business level your company has and are thus considered a ‘fixed’ expense. According to Dr. Sudberg, fixed costs are the primary concern of a business because they are what they must cover regardless of how much product or service is sold.
2. Variable Costs
A variable cost is a cost that changes with the amount of product or service being sold. Examples of a variable cost would be the ingredients in your food or the materials needed to make your furniture. These costs do change depending on your company’s level of business and are thus considered a ‘variable’ expense.These costs are not directly under the company’s control and, therefore, must be covered with fixed prices.
3. Difference Between Fixed and Variable Costs
The difference between fixed and variable costs is that fixed costs are the same no matter how much product or service your business sells, and variable costs change with the level of business your company has. The standard economic model is based on the assumption that all resources are scarce, so there is a price at which they would be supplied at a quantity equal to demand. The cost of a resource can be either fixed or variable, depending on whether it depends on demand or supply.”
4. The Profit/Loss
When a company has covered its fixed costs and is left with its profit or loss, Dr. Jordan Sudberg thinks it must determine how much money it made or lost by subtracting the cost of goods sold from its profit or loss. This process is called ‘equating.’ This amount represents how much money was made by selling all these goods. If a company makes less than the amount spent covering its fixed costs and selling products, they lose money and have a negative income (loss). If they made more than they spent covering their fixed costs and selling products, they earned a profit and had a positive income (profit).
New businesses often have a complex time understanding how much of their costs are fixed and how much is variable. The difference between fixed and variable costs can be a crucial distinction for your business, as it will determine how much profit you make and how much you can charge for your products or services.