Fixed Cost and Variable Cost: Definition, Difference, Examples
Fixed Cost and Variable Cost – Generally there are two types of expenses in business finance terms, namely fixed costs and variable costs. Find a more complete explanation in this article.
What is Fixed Cost?
Fixed cost is a fixed cost that must be paid by a business activity/company that is carried out constantly and the amount does not change significantly – even though there is an increase or decrease in the productivity of the business/company activity.
The goal is to provide a clear picture of the number of fees that must be paid by entrepreneurs. Fixed costs over a short period may not experience significant price changes.
It is no exception if there are external factors that affect a price, such as a recession, political shocks, or macroeconomic developments in a country.
For entrepreneurs, Fixed costs are fixed and stable so that payments can be anticipated by making a good budget allocation for at least the costs incurred remain stable.
The running of the industry certainly requires sound financial reports. If ignored, it will disrupt the continuity of business activity and its operations in it.
A sound financial report must pay attention to the number of expenses that must be paid at a certain time.
Types of Fixed Costs
Fixed costs in accounting science are divided into two types. Here’s the full explanation:
1. Committed Fixed Cost
Committed fixed costs are Fixed costs that have an absolute determination and have been agreed to remain in any condition.
This type of Fixed cost must be incurred within a certain period to maintain the continuity and stability of business activity.
Committed fixed costs are also closely related to the expenditure of human resources and the organizational structure in it.
When a company goes bankrupt, there are costs to be incurred. So that the committed Fixed costs must be incurred to comply with the provisions of the legislation in force in a country.
2. Discretionary Fixed Cost
Discretionary fixed costs are fixed costs that are issued situationally and are flexible, according to certain conditions and times.
The costs incurred must not have a significant impact on the profit generated. Generally, companies set discretionary fixed costs in a small ratio, compared to committed fixed costs.
Especially when the company suffers losses or decreases in profits that can disrupt the continuity of business operations.
Fixed Cost Examples
Generally, some fixed fees must be paid by the entrepreneur. Some of the fixed costs incurred, among others:
1. Officer Salary
Salary expenses usually have a large ratio compared to other costs. Salary is very closely related to the agreement between employees and business actors. So that its role has permanent legal force.
In addition to the payment of salaries, several instruments attached to it must be paid by employers, such as taxes, insurance, and pension costs that have been determined by the state and must be paid every month.
2. Rent Business Place
If you choose to rent a place of business, you are required to pay for the place of business to maintain business continuity.
The costs incurred will remain stable on a monthly/annual basis. Usually paying for the long term will be more efficient than paying for the short term.
3. Company Instrument Depreciation Cost
Some items in the company’s instruments will experience constant depreciation/decrease. The depreciation value must be part of the company’s expense and must be paid by the company every month.
Assets or often referred to as fixed assets that have decreased include:
- Business machine.
- Operational vehicle.
- Physical office building.
- Internet Network.
- There are many more.
The more time goes by, the more the costs will be. So renewal with the latest technology must be done to minimize depreciation costs that are increasingly burdening the company.
4. Interest Charge
Fees are charged as a result of the loan process to the company and are charged to monthly installment financing.
5. Insurance Fee
The cost of protection services if something unexpected happens and is detrimental to the company. The fee is paid as an insurance premium.
Contributions must be issued by entrepreneurs to the state to ensure the continuity of a business and operate legally. Some of the tax fees charged are property taxes, building land taxes, excise fees, entrepreneur taxes, and many more.
Costs that must be incurred to ensure operational activities work well and smoothly. Utility costs paid such as electricity bills, telephone, internet and so on.
That’s the discussion about what fixed cost is, then let’s learn about the variable cost. Both are costs that must be paid by the company.
What are Variable Costs?
Variable costs are variable costs incurred depending on the results of production or certain conditions/periods.
Variable costs are constant amounts with the resulting production. Under certain conditions, variable costs can be a major burden on the company’s budget.
The greater the production, the higher the variable costs. However, if the production is low, the variable costs incurred in a certain month will decrease.
The determination of variable costs will differ from one industry sector to another, in addition to scalability, production levels, and market aspects that will affect the variable costs incurred.
Fluctuations in business assets will also affect the number of variable costs.
Types of Variable Cost
In the science of accounting, variable costs are divided into four types. Here’s the full explanation:
1. Direct Cost
Direct costs are variable costs that are directly related to production activities. Usually, the costs incurred are crucial and must be spent to maximize production results.
Examples such as raw material costs, raw material costs, fuel costs, distribution costs, and many more.
2. Variable Overhead Cost
Variable overhead costs are variable costs that are closely related to the company’s intensity in production activities.
Some of the costs charged include work accident insurance, labor insurance, environmental impact costs, and revitalization of business activity.
Variable overhead costs can change as the company plans to determine the value of productivity achievements. So the value of the fluctuation is not fixed.
3. Semi-Variable Cost
Semi-variable costs are variable costs that have elements similar to fixed costs but are issued conditionally.
Semi-variable costs are classified as minimum costs that must be paid in providing services and following the volume of production activities within a certain time.
4. Ratio Variable Cost
Ratio Variable Cost is the ratio of variable costs listed in the financial statements to describe the magnitude of the production process that occurs at a certain time.
The value of the variable cost ratio is derived from the percentage of net sales over a certain period.
The ratio of variable costs is a comparison of production costs with the amount of income generated from production activities. The amount is flexible so that management can determine the next decision to increase production activities or not.
Variable Cost Examples
Generally, several variable costs must be paid by entrepreneurs. Some of the variable costs incurred include:
1. Profit Commission
Marketing activities are the spearhead of the company’s survival. Employees who are in it and are directly related to company profits are usually charged with various sales targets.
When the employee has exceeded the set target, there is a profit commission that must be paid by the employer.
Generally, the profit commission is a percentage of the total profit generated. The percentage is an agreement between employees and employers.
The higher the sales results obtained, the higher the variable costs incurred.
2. Additional Labor Cost/Direct Labor
Labor related to production activities will be a variable cost in the financial statements.
The workforce must have a significant role in increasing the production results obtained. Generally, this can occur when it occurs during peak sales season or when there is an increase in orders.
Overtime costs can be included in variable costs because there is additional time outside of working hours and must be paid.
In addition, when recruiting freelance workers or outsourcing employees usually have a short period. So it is classified as a variable cost.
3. Distribution Fee
When a company carries out export or import activities, there will be distribution costs which are considered variable costs.
The expedition will adjust the cost according to the distance between the sending area and the receiving area.
The costs inherent in it may occur such as the cost of procurement of goods, warehouse costs, and many more. The amount of the fee depends on the amount of capacity that is sent and stored at a certain time.
4. Company Instrument Service Fee
Some of the company’s instruments may require further maintenance to work optimally.
Usually, the service/maintenance costs are adjusted according to the provisions in the tool manual book. For example, a vehicle at a certain distance must be maintained on a certain scale.
The costs to be incurred will depend on the weakness/damage in the company’s instruments. Regular maintenance and proper use can increase the service life of a production tool.
Difference between Fixed Cost and Variable Cost
Some of the differences between fixed costs and variable costs that can be considered include:
The characteristics of Fixed costs are classified as stable/fixed costs. While variable costs are classified as fluctuating costs/changes according to company conditions.
The time constraint specified in the fixed cost is fixed/does not change over a certain period (inclines over a long period).
While variable costs do not need to adjust to time variable costs use the determination of the volume of products produced in a certain period.
3. Product Inventory Value
The value of the product inventory/production results will not be affected by the fixed cost. The variable cost will have an effect because it relates to the value of the resulting production.
This is because it will be a cost that varies depending on the quantity of product produced. That’s a complete explanation of Fixed costs and variable costs, as well as the differences between the two.
As an entrepreneur, understanding and classifying fixed cost and variable cost ratios correctly will maximize the profit that will be obtained. Recording measurable and systematic financial reports can develop the business in the future.