The Difference Between Variable and Fixed Business Expenses
Business expenses are costs that sustain a business. Also known as deductions, business expenses are recorded on the income statement and are subtracted from your business revenue to determine your company’s net profit or loss and taxable income.
It’s important to note that various expenses can be associated with managing and maintaining a business. These expenses can either be variable or fixed. As a business, you can benefit from knowing the difference between the two types of business expenses and learning to utilize them to help your business. Let’s understand the differences between variable and fixed business expenses.
Variable Expenses
Variable expenses are referred to as corporate expenses that change based on how much your company produces or sells. Variable costs increase as the volume of your business activities increases and go down when the volume of activities decreases. The most common variable costs include direct materials, direct labor, commissions, transaction fees, utility costs, and billable labor.
Paying attention to your business expenses plays a prominent role in your business’s financial planning process. It helps your business take all legitimate write-offs, pay the proper amount of tax, and create an effective financial plan. Understanding the proportions of your variable costs is also imperative since high ratios indicate that your business can continue functioning at a relatively low sales level.
Other variable costs may include delivery charges, salaries, shipping charges, or wages. Performance bonuses paid to employees are also considered variable costs. In most cases, it is easy to reduce and manage variable costs even without disrupting as opposed to fixed expenses.
Every business, no matter the size, incurs variable costs. However, the cost structure varies from industry to industry, and variable costs are not easy to predict. But, your ability to plan for growth and handle your downtime is what can keep you afloat and lead you to business success.
Fixed Business Expenses
Fixed business expenses refer to costs that do not change whether there is an increase or decrease in the number of goods and services produced or sold. Fixed business expenses are costs your company has to pay and are independent of any specific business activities. Fixed costs are indirect, so they don’t apply to your company’s production of any goods and services.
The total costs of running your business can be broken out by direct, indirect, and capital costs on the income statement. The costs can also be annotated on your balance sheet by short-term or long-term liabilities. Either way, both fixed and variable business expenses make up the entire cost structure of your company and are vital factors that influence your overall company profitability.
Since fixed costs don’t change over time, they are usually established using contract agreements and schedules. Your fixed business expenses are generally the base costs involved in operating your business comprehensively. Once you establish fixed expenses, they do not change as long as the agreement or cost schedule is alive.
In your income statement, you can allocate your fixed expenses in the indirect expense section, which leads to operating profit. To produce more profit, you can structure your business to have a higher proportion of fixed expenses than variable costs.
However, a few costs can be considered fixed over a long time. For instance, if you constantly make merchandise like custom plastic cups, over time they can be regarded as a fixed expense based on the amount of output produced.
Depreciation is a profound aspect of fixed costs recorded as an indirect expense. You can create depreciation expense schedules for your asset investments, with the values falling over time. For instance, if you are in the manufacturing sector, you might buy machinery for your assembly line to be expensed over time using depreciation. Salaries for management are also an indirect cost.
If you incur any fixed costs on your income statement, you can account for the costs on the balance sheet and cash flow statement. Fixed expenses on your balance sheet can either be short-term or long-term liabilities. Generally, tapping into opportunities to help lower your business’s fixed expenses can benefit your company’s bottom line and increase profit.
Semi-Variable Costs
It is also important to note that there are business costs with components that are fixed and variable at the same time. These costs are also referred to as semi-variable costs. An example is the sales wages for the sales team.
A portion of your sales force’s salary can be fixed; the rest, the sales commission, is variable. Therefore, when doing calculations, make sure that you allocate the fixed portion of wages to fixed costs and the other portion to variable expenses.
