Fixed Costs

Meaning of Fixed Costs


Fixed cost definition

Fixed costs are costs that occur continuously and at a constant level in a company. In addition to the variable costs, they are part of the total costs.

Fixed costs are incurred at regular intervals (monthly, quarterly). They arise regardless of the workload of the employees and the amount of manufactured products or services and are even present in the event of production stoppages and the establishment of a company. If they increase, this is related to other factors such as a rent increase. Fixed costs are part of the so-called overhead costs because they cannot be allocated directly to a cost center or cost unit. Usually they are higher than the variable costs.

Jump fix costs definition

Interval-fixed or step-fixed costs are costs that remain the same for a certain period of time, but then rise sharply and then remain constant at this level. This creates a cost function that is similar to a staircase with steps. The reason for the drastic increase in costs is, for example, the purchase of an additional machine because the previous machine can no longer produce the required number of pieces. If the existing machine caused fixed costs of 500 euros, a further 500 euros are now added. This also applies if only one additional piece is produced. Fixed costs often lead to the fixed cost trap if the additional fixed costs are not covered by significantly higher sales revenues. In extreme cases, the company can even make losses.

Fixed cost examples

According to aviationopedia, the classic fixed costs in companies include:

  • Rental costs for business premises, production halls, storage rooms
  • Fixed wages and salaries
  • Telecommunication costs
  • IT costs
  • Insurance costs
  • Straight-line depreciation costs
  • Maintenance costs
  • Leasing costs (vehicle fleet, computer)
  • Interest costs (loans)
  • Building cleaning costs
  • Tax consultancy costs

Difference between fixed and variable costs

Fixed and variable costs are both components of the total costs. In contrast to variable costs , however, fixed costs can be calculated over the long term because they are usually always incurred in the same amount. Variable costs are based on the company’s output. In contrast to fixed costs, variable costs are not always overhead costs. Some variable costs can also be assigned to specific cost centers. It is also possible to influence the changing costs more quickly and easily than the fixed costs.

Typical variable costs in a company are:

  • The larger the number of items produced, the higher the energy costs incurred in production. However, this only affects the variable portion of the electricity costs. The basic fee charged by the energy suppliers is one of the fixed costs. In order to simplify the calculation, the electricity costs incurred for the lighting and the technical devices used in administration (PCs, fax machines) are added to the fixed costs and the energy costs caused by the production systems to the variable costs.
  • The raw material costs are also assigned to the variable costs: Your purchase price is usually based on the quantity ordered and can therefore be influenced by the buying company.

Calculate fixed costs

The regular control of the fixed costs is very important for the company, because if they are too high, its liquidity deteriorates . A fixed cost analysis helps to identify particularly cost-intensive areas. Savings should then be made there. The basis of the fixed cost calculation is a cost center analysis. You can see immediately which fixed costs have the highest share of the total costs and which can now be canceled.

Calculating fixed costs can be very simple by rearranging the total cost function and subtracting the variable costs from the total costs:

Total cost formula

Total costs = fixed costs + variable costs

Fixed cost formula:

Fixed costs = total costs – variable costs

This type of fixed cost calculation is very suitable for households. If this method is used in companies, however, it quickly becomes clear that the distinction between variable and fixed costs is not always easy to recognize. The so-called shift cost method is suitable for this :

Step 1:
Estimation of the minimum and maximum expected output within a production shift and the corresponding costs.

Minimum service: wages for 10,000 items → 44,000 € costs
Maximum service: wages for 42,000 items → 76,000 € costs

Step 2:
Shift costs: Determination of the difference between the two services and the corresponding costs.

42,000 pieces – 10,000 pieces = 32,000 pieces
€ 76,000 – € 44,000 = € 32,000

Step 3:
Division of the shift costs by shift work results in average unit costs for the shift.

32,000 € / 32,000 pcs = 1 € / pc

Step 4:
Multiplication of the number of goods units to be produced by the calculated unit costs.

Goods to be produced: 15,000 pieces
15,000 pieces * 1 € = 15,000 € → variable costs

Step 5:
Subtract this amount from the total costs to calculate fixed costs.

38,000 € – 15,000 € = 23,000 € → fixed costs

Effects of too high fixed costs

Fixed costs can have serious consequences: the more fixed obligations a company has, the greater the risk of becoming insolvent. Falling production and sales figures can mean that the company can no longer cover its fixed costs to the usual extent. Unpaid invoices result in long-term reminders and even legal proceedings. In extreme cases, there is even a risk of company bankruptcy.

Contribution margin definition

The contribution margin is an economic key figure. It indicates to what extent a company is able to cover its fixed costs financially. The contribution margin can be calculated for the entire company, for individual product groups and even for a single manufactured item.

Contribution margin formula:

Sales proceeds – variable costs = contribution margin

Interpretation of the contribution margin (DB):

DB> 0 It
is the goal of every company that the contribution margin calculation produces a positive result. The variable costs are covered in full and the amount of the contribution margin expresses the extent of the fixed cost coverage.

DB = 0
If the contribution margin is zero, no fixed costs can be covered, only the variable costs. A neutral contribution margin is often used when companies produce at their lower price limit .

DB <0
A negative contribution margin is always a very bad sign for a company, because if this is the case, neither fixed costs nor variable costs can be fully covered.
The larger the contribution margin, the more valuable the respective product is in terms of cost recovery for the manufacturing company.

Break-even analysis

The fixed costs also play an important role in the break-even analysis. It is used to determine break-even , i.e. the point at which the company or a newly introduced product reaches the profit zone. At break-even, income is just as high as expenses. To find out whether a project can be implemented, the break-even analysis is used to calculate the required sales volume from which the break-even point is exceeded. The break-even calculation is carried out in accounting using the following formula:

Z and calculating sales volume = fixed costs: (selling price / item – variable costs / item)

Reduction of fixed costs

Fixed costs are reduced in different ways:

  • Entrepreneurs can do without a certain new acquisition and try to compensate for this through alternative measures. If it is a machine, it is sometimes possible to manufacture the new product on the existing production facilities.
  • The permanent employment of an additional employee in case of order peaks can usually be avoided by the cheaper outsourcing .
  • The introduction of flexible working hours, which are adapted to the order situation, is also a tried and tested alternative.
  • When purchasing new office furniture, the entrepreneur could opt for high-quality used furniture.
  • Instead of a representative building, young start-ups choose a normal office building for their new business premises.
  • In addition, fixed costs that are too high can often be reduced by changing provider. It is best to check all contracts for this.

Fixed Costs