Meaning of Fixed Costs
Fixed costs are expenses that remain constant regardless of changes in sales or production levels. This is due to the fact that they are not directly involved in producing a product or providing a service. Consequently, fixed expenses are regarded as indirect costs.
Fixed costs are costs that do not change regardless of the volume. In general, costs that are considered to be fixed are those that are calculated based on time rather than the quantity of goods or services that are produced or sold by your company.
The cost of rent and leasing space, wages, energy bills, insurance premiums, and loan repayments are all examples of fixed expenditures. Fixed expenses are also associated with some types of taxes and company licences. You should proceed with caution when considering the addition of fixed expenses to your small business. This is because you are required to pay fixed costs no matter how much you sell. The term “overhead” is frequently used to refer to fixed costs.
In order for company owners to properly manage their costs, they need to have a solid understanding of the costs their companies face. Because certain expenses are not variable, the percentage rise in total costs will be smaller than the percentage increase in sales and production. As a general rule, higher sales and production volumes lead to higher total costs.
Relevance of Fixed Costs
Fixed costs are important to consider when making decisions about pricing, production levels, and other aspects of business operations. They can have a big impact on profitability and should be carefully managed.
When trying to control fixed costs, managers may look at ways to reduce them or shift them to variable costs. For example, they may negotiate better rates with suppliers or try to reduce the amount of office space they lease.
In some cases, it may make sense to increase fixed costs in order to save money in the long run. For example, a company may decide to lease rather than buy office space, even though the upfront cost is higher. This can be a good option if the company is confident that it will grow and need the extra space in the future.
Fixed costs can also be a useful tool for management accounting. They can be used to allocate resources and track spending. By understanding fixed costs, managers can make better decisions about where to allocate resources and how to control expenses.
Can Fixed Charges Change?
Fixed costs don’t change based on how many units are produced. The total fixed costs stay the same as long as they stay within the relevant range. But as production goes up, the fixed cost per unit goes down because the same fixed costs are spread out over more units.
Fixed costs will not go down when the business size goes down, as long as the fixed costs are being paid. For example, if the size of the business is going up and the fixed costs are the same, then the profit rate will be the same.
The relevant range is the activity range (e.g., production or sales) across which these correlations hold true. For instance, if the factory is working at full capacity, expanding output necessitates the incurrence of extra fixed expenditures in order to expand the facility or lease or construct a new plant.
Alternatively, the output may be dropped below a threshold when one of the company’s factories is no longer needed, and the fixed expenses associated with that plant can be avoided. Regarding variable expenses, the business may be eligible for a volume discount on fabric purchases beyond a certain production level.
The applicable range for classifying fabric as a variable cost terminates at this production level because the fabric cost per output unit is different when the plant produces above and below this threshold.