✏️ Fixed cost is an expense that businesses incur to run the business, but the amount stays the same regardless of the volume of sales and production.
Example: office rent, rent for warehouse, depreciation expense, insurance, and monthly subscriptions that do not change in price based on usage
✏️ Variable cost is an expense that changes in amount depending on the volume of sales and production.
Example: material used for the products sold, commission, utilities, and shipping
💡 Why is it important to know the difference?
I would say that you don’t need to remember the examples of each cost.
However, if you are a business owner who runs the business AND takes care of the financial side of planning, you want to know which item in your business’s P&L is variable and fixed.
Knowing the difference is very helpful for many things – from putting together the budget for next year to making an important decision in your business.
For example, when you consider investing in marketing, you want to have an idea of a return on the investment.
How much the sales is expected to increase in volume and $, and the associated costs.
If the sales increase does not exceed the cost of the marketing investment + all other “variable” costs, you will have a loss on the investment.
As a business owner though, it is not easy to do all the analysis before making the decision. It is too detailed for the owners to spend their valuable time on.
This is why having a finance expert (CFO) internally or an advisor (outsourced CFO) is important for growth of business. 🙂
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