Fixed costs vs variable costs: Businesses and investors need to know

Why Cost is Important for Financial Decision-Making

When discussing business management or evaluating the potential of investment projects, the first thing to understand is the cost structure of that business. The difference between fixed costs and variable costs that fluctuate with production volume has a significant impact on pricing, break-even point estimation, and long-term growth planning.

Additionally, for VC investors (Venture Capital) or even startup entrepreneurs, understanding these two types of costs is key to efficient operations and making decisions about whether to invest in fixed costs (Fixed Cost) or variable costs (Variable Cost) more extensively.

What is a Fixed Cost (Fixed Cost)

Fixed costs are expenses that a company must pay regardless of whether the business produces a lot or a little. They can be described as costs that are “mandatory” to pay every month or year, with no way to avoid them.

Key characteristics of fixed costs

Remain constant regardless of increase or decrease in production - Whether you produce 100 units or 10,000 units, these costs stay the same, unlike variable costs which increase with production volume.

Important for financial planning - Businesses can use fixed costs to forecast revenue and estimate the break-even point because they are stable and predictable in advance.

Common examples of fixed costs

• Building/office rent: A regular expense that entrepreneurs pay monthly, regardless of production levels
• Employee salaries: Especially permanent staff or executives with fixed salaries that do not depend on sales volume
• Insurance premiums: Expenses for insuring equipment, assets, or legal liabilities
• Depreciation: Accounting for the wear and tear of equipment, machinery, or buildings over time
• Loan interest: Costs that must be paid periodically if the business has borrowed funds from financial institutions

What is a Variable Cost (Variable Cost)

Variable costs are expenses that change according to the level of production or sales activity. If production increases, these costs will increase proportionally, and if production decreases, these costs will decrease as well.

Key characteristics of variable costs

Increase or decrease with production volume - The flexibility of variable costs allows businesses to adjust expenses based on market demand, enabling quick responses to changes in demand.

Impact on per-unit cost - Managing variable costs well will reduce the cost per unit as production volume increases because fixed costs are spread over more units.

Examples of variable costs in business operations

• Raw materials and manufacturing: Costs of materials or components used to create products, which increase with higher production
• Labor (hours): If hiring labor based on hours or tasks, costs depend on the production volume
• Energy and utilities: Electricity, water, and energy used in the manufacturing process vary with usage
• Packaging and shipping: Costs for packaging products and delivery increase with higher sales volume
• Commissions: Payments to sales staff based on sales performance

Main Differences Between Fixed and Variable Costs

Cost Total Analysis for Business Decisions

Combining fixed and variable costs is called Total Cost (Total Cost), and this analysis is very useful for business management.

Proper Pricing Strategy

Businesses must ensure that the selling price exceeds the total cost sufficiently to generate profit, considering both fixed and variable costs.

Break-even Point Analysis (Break-even Point)

Calculating the break-even point is essential because it shows how many units need to be sold to recover all costs.

Investment Decisions

Deciding whether to invest in additional fixed costs (such as purchasing more equipment) to reduce long-term variable costs is a critical decision.

Growth Planning

Businesses with high fixed costs benefit more from increased sales volume because fixed costs are spread over more units.

Cost Management Recommendations

For entrepreneurs: Closely monitor both types of costs because understanding your business’s cost structure will help you make smarter decisions about pricing, expanding production, or cost-saving measures.

For VC investors: Assessing how startups manage fixed and variable costs will help you understand the risks and profit potential of those companies.

In general: Improve the efficiency of variable costs through increased productivity or sourcing raw materials at better prices, and try to keep fixed costs at an appropriate level relative to the business size.

Summary

Fixed Cost (Fixed Cost) and Variable Cost (Variable Cost) are fundamental concepts that everyone involved in business management, investment, or VC operations must understand clearly. Recognizing the differences between these two types and applying this knowledge to financial decision-making will help your business or investment project manage resources more effectively and sustainably in the long run.