Fixed and variable costs: Why is it important for your business to know how to differentiate them?
Posted: Sun Dec 22, 2024 7:16 am
What does it depend on whether it is fixed or variable? Basically, whether it changes when the level of production increases or decreases, whether for products or services. That is, if the production of a product or service increases and the cost also increases, then it is a variable cost. On the other hand, if the production of a product or service increases or decreases and the cost remains unchanged, it is a fixed cost.
Now let's see it with more everyday examples.
Rent: This cost is common in businesses and has the peculiarity that it generally does not change. You always pay the same amount each month. If you sell twice as many units in your business one month as the previous month, will the rent be more expensive? Probably not, it will remain the same and we will be dealing with a fixed cost.
Raw material: Let's say you have a food establishment that sells hot dogs. One month you sell 100 units, which costs $300 per unit of bread, resulting in selling those 100 hot dogs costing you $30,000 worth of bread. But the next month you sell 50 hot dogs, so the cost of bread drops to $15,000, and then the following month you sell 200 hot dogs, raising the cost of bread to $60,000. In this case, the cost of bread changes if production increases or decreases, so it would be a variable cost.
You've probably heard about fixed and variable costs. Knowing the difference mobile number philippinesbetween them plays a key role in your business's accounting, especially in times of uncertainty, where maintaining as much liquidity as possible can be a key factor in the survival of your business.
A fixed cost allows us to cover essential needs and services. These costs generally do not change in the short term. That is, they will not decrease significantly in weeks or months. Nor will they depend on the volume of production. However, in the long term, these costs may experience variations because they are affected by situations in the macroeconomic environment.
On the other hand, a variable cost changes constantly and follows a direct relationship with the production volume of your business. If you produce more, these costs will increase and if you produce less, they will decrease.
Why is it important to know how to differentiate between fixed and variable costs?
It helps us prevent cash flow problems. Periodically reviewing fixed and variable costs and comparing them with the level of sales and income means controlling cash flow. This is how you can detect potential liquidity problems in your company and, if you do it in time, you can take the necessary measures to avoid a collapse.
Determine ideal revenue: Knowing how much your total costs are (the sum of fixed and variable costs) will help you determine how much revenue you need to generate to cover these costs. It will also help you take a closer look at your margin and play around with these numbers.
Setting prices correctly: In these times, setting prices that are attractive to your customers is a whole topic in itself. If you do it well, you will be able to attract and retain them. By analyzing your fixed and variable costs, you will be able to see in detail “to what extent you can move your prices”, for example, lowering them to create attractive offers without the risk of losing your entire profit margin.
You already know the importance of identifying and recognizing your fixed and variable costs because it allows you to have greater control over your business and make better decisions.
Juan Ramon Munoz
Now let's see it with more everyday examples.
Rent: This cost is common in businesses and has the peculiarity that it generally does not change. You always pay the same amount each month. If you sell twice as many units in your business one month as the previous month, will the rent be more expensive? Probably not, it will remain the same and we will be dealing with a fixed cost.
Raw material: Let's say you have a food establishment that sells hot dogs. One month you sell 100 units, which costs $300 per unit of bread, resulting in selling those 100 hot dogs costing you $30,000 worth of bread. But the next month you sell 50 hot dogs, so the cost of bread drops to $15,000, and then the following month you sell 200 hot dogs, raising the cost of bread to $60,000. In this case, the cost of bread changes if production increases or decreases, so it would be a variable cost.
You've probably heard about fixed and variable costs. Knowing the difference mobile number philippinesbetween them plays a key role in your business's accounting, especially in times of uncertainty, where maintaining as much liquidity as possible can be a key factor in the survival of your business.
A fixed cost allows us to cover essential needs and services. These costs generally do not change in the short term. That is, they will not decrease significantly in weeks or months. Nor will they depend on the volume of production. However, in the long term, these costs may experience variations because they are affected by situations in the macroeconomic environment.
On the other hand, a variable cost changes constantly and follows a direct relationship with the production volume of your business. If you produce more, these costs will increase and if you produce less, they will decrease.
Why is it important to know how to differentiate between fixed and variable costs?
It helps us prevent cash flow problems. Periodically reviewing fixed and variable costs and comparing them with the level of sales and income means controlling cash flow. This is how you can detect potential liquidity problems in your company and, if you do it in time, you can take the necessary measures to avoid a collapse.
Determine ideal revenue: Knowing how much your total costs are (the sum of fixed and variable costs) will help you determine how much revenue you need to generate to cover these costs. It will also help you take a closer look at your margin and play around with these numbers.
Setting prices correctly: In these times, setting prices that are attractive to your customers is a whole topic in itself. If you do it well, you will be able to attract and retain them. By analyzing your fixed and variable costs, you will be able to see in detail “to what extent you can move your prices”, for example, lowering them to create attractive offers without the risk of losing your entire profit margin.
You already know the importance of identifying and recognizing your fixed and variable costs because it allows you to have greater control over your business and make better decisions.
Juan Ramon Munoz