What are fixed costs in business?

Fixed costs in business are financial responsibilities that stay relatively constant no matter how much your company produces in a given period. Rent and your monthly insurance fees are good fixed cost examples.

Reducing your fixed costs directly impacts your company’s bottom line. So, understanding how this type of business expense works can help you make informed decisions regarding your profit margins. 

In this article, we’ll take you through the definition of fixed costs, show you how to calculate them and discuss how they differ from variable costs.

What are fixed costs?

Fixed costs definition

Fixed costs are business expenses that are not affected by how much your company produces in a specific period. 

When you start a new business, you will have various fixed expenses to get your company off the ground. You will likely need a space to operate from, business licenses, and insurance. All of these expenses will not be directly linked to your production levels. They will therefore be fixed costs. 

As you start producing items for your company to sell, your expenses will fluctuate according to how much you produce. These are not fixed costs.

Say you have a sudden influx of orders that requires you to up your production levels. While your expenses for the month will likely go up — you may need additional materials and labour, for example — your fixed costs will remain constant. Same goes for slow months — you’ll still have to pay for things like rent and insurance fees, even if you get zero orders in.

Fixed costs are generally: 

• Recurring — monthly, quarterly or annually. On the upside, that makes them predictable. You know that every month, for example, you must spend x amount of pounds on your mortgage payments, regardless of how many popsicles you produce and sell. 

On the downside, you have to factor in these expenses even if production costs are higher than usual or sales are lower. If the cost of making popsicles goes up, that rent bill will still be there, salaries for permanent workers will still have to be paid, and the insurance bill will still come in. 

• Indirect — meaning they are unrelated to a particular product or service. Instead, they are tied to day-to-day operations that keep your business afloat. This type of fixed cost is known as overhead.

However, there are instances when fixed costs are related to a particular product or service and can be considered direct.

Think, for example, of the cost of renting a workshop to produce a specific product you sell. While the rental cost won’t change significantly from month to month according to production levels, it is directly related to the production of that product and that product alone. 

The rent for an office space that houses your whole business, on the other hand, will be considered an indirect cost as it’s not related to one particular product you produce or service you offer.

What are examples of fixed costs in business?

Examples of fixed costs in business include:

• Rent and lease payments 

• Mortgage payments 

• Salaries for management and other long-term employees

• Operating licenses

• Insurance

• Depreciation of assets. Depreciation is an indirect cost if the asset is not related to the production of a specific product or service you offer. An example here would be the depreciation of the computers you use to run your business. 

If, however,  the asset is directly related to the production of a particular product or service, it could be considered a direct fixed cost. You can tie the cost of production of that item to the asset. 

Say, for example, you use a printer for the sole purpose of creating stickers of your artwork. However, these stickers are not your only offering. You also sell mugs, totes and keychains. The depreciation of the sticker printer is related to the production of stickers alone and is therefore a direct cost. 

What is the difference between fixed and variable costs (and why does it matter)?

The main difference between fixed and variable costs is whether they are tied to how much you produce in a particular period:

• Fixed costs (like rent for an office space) will not be impacted by whether you have high production costs for a particular period.
• Variable costs (like raw materials) are related to your production levels.

That doesn’t mean that fixed costs are set in stone — rent goes up, insurance premiums fluctuate, and salaries increase. It does mean, however, that whatever changes happen are not tied to production.

Examples of variable costs include: 

• Materials you need to create a product
• Wages of contract labourers employed for a specific task
• Packaging and shipping costs
• Utility costs, such as electricity and water, that are directly related to the production of a particular product. They will go up and down based on how much you produce. 

Some costs are a hybrid of fixed and variable costs. They might start life as fixed and then become variable after a particular time. A good example of this is the purchase of heavy equipment that you need for your business to operate. While it will be a fixed cost initially, it may need repairs down the line. Those repairs could become a variable cost.

How to work out fixed costs

The fixed cost formula is as follows:

Fixed costs = Total expenses - (variable cost per unit X number of units produced)

Here’s how to use it to calculate your fixed expenses:

1. Add up all your expenses for a given period.
2. Multiply the number of units you produced in that same period by the VARIABLE cost per unit. Remember that these are things like packaging, shipping and raw materials — costs directly related to how much you produce. 
3. Subtract your answer from your total expenses (calculated in point 1).
4. Your answer will be the total of your fixed costs.

Fixed costs FAQs

Where do you record fixed costs in business?

Fixed costs are typically recorded on your income statement, also known as a Profit and Loss statement. This financial statement tracks your company’s total income, loss and expenditure over a specific period. 

Fixed costs are part of your calculation of your operating profit (your earnings after all of your expenses have been deducted).  

Fixed costs may also be recorded on your balance sheet, which gives an overview of your financial situation at a particular point in time, and the cash flow statement, which tracks the money coming in and out of your business over a given period.

Why do we record fixed costs in business?

Assessing the fixed costs of doing business will allow you to analyse the overall success of your enterprise and help you make decisions accordingly. 

When compared against your expenses, is the income you are generating sufficient to float your business, or do you need to reduce the amount of money that you have to consistently pay out? Finding out the point at which income matches output is called a break-even analysis.

If you are already making a profit, you might want to use your fixed (and variable) costs to determine your margin of safety — how much your revenue can drop before you stop making that profit. To do so, it’s important to factor in both fixed and variable costs.  

For more information, read our article on margin of safety

Are all fixed costs sunk costs?

Some fixed costs are considered sunk costs in that you won’t be able to recover a part or the whole of them. (Rent is a good example here.) 

However, this is not the case for all fixed costs. For example, you may be able to recoup money that you spent by selling off machinery or property you have bought for your business.

Quickfire summary: what are fixed costs?

Fixed costs in businesses are expenses that are unaffected by production levels. Rent and mortgage payments, business licenses, and salaries for permanent employees are examples.

Fixed costs are typically:

• Recurring, meaning you have to make payments on a monthly, quarterly or annual basis.
• Indirect, meaning they are unrelated to a specific product or service you offer. (There are exceptions here, such as rent for a workshop that is purposed towards creating a particular item
• Recorded on the income statement, balance sheet and cash flow statement.

Variable costs, on the other hand, go up and down according to how much your company produces. Materials, contract labour, packaging and shipping costs are examples here.

To calculate fixed costs, you multiply your variable cost per unit but the number of units you produce in a particular period, and subtract that number from your total expenses.