Fixed Costs Explained
When preparing a break-even analysis the main objective to cover your fixed costs. This is where you make zero profit or loss and if your break-even points. It simply means you have enough sales income to cover the costs of maintain your business.
A fixed cost is defined as: an expense which doesn't change in value if one more unit of sales or production is made.
Those which change if one more sale is produced are called variable costs. These increase or decrease with the volume of marginal sales made and are generally those directly related to generating the sale.
Once you have reached your break even point your next objective when preparing your financial plan is to make your desired profit targets. Financial planning will help deliver the correct margins on sales to cover all fixed and variable costs profitably.
What Costs are Fixed ?
One approach to this question is to decide which costs would be incurred if you had no sales tomorrow or didn't produce anything.
These are the foundation costs in a business that do not change on a marginal basis. Some fixed costs will increase if you reach a certain level of sales (for example, expanding your premises) but for expenses on a day to day basis there is no change. They have to be paid whatever happens.
Here are examples of costs that are essentially fixed in a business :
- Monthly rental payments
- Local council business rates
- Electricity and gas
- Salaries, pension and National Insurance contributions
- Other utility costs
- mortgage and loan repayments
- Vehicle leasing costs
- Accountancy costs
- Most marketing costs
These costs would not change whether you made 0, 1 or 10 sales today. Variable costs would be directly associated with that one sale for example:
- Raw materials
- Online bank charges (per sale)
- Delivery costs