Running a business involves investing in expenditures that help you sustain, secure and scale your business. When it comes to business costs, owners mainly look at two forms of expenses – those related to fixed and variable costs.
Fixed costs are those that are not affected by the production volume of your business. These remain the same with each passing month, and need to be paid on a regular basis. Your fixed costs can include expenses related to rent and leases, salaries and overhead costs, taxes etc.
Variable costs on the other hand, are highly dependent on your production volume. When your production volume goes up, so do your variable costs, and vice versa.
If you want to create a solid financial management strategy for your business, then you need to consider looking into your fixed and variable costs.
What Are Fixed Costs?
Business owners will always encounter fixed costs when running a business. If you hire employees, then the salary you pay them counts towards fixed costs. This does not apply to salary commissions and bonuses. Only the amount needed to be paid as wages to all your employees fall under business costs.
Similarly, other expenses that you need to pay on a recurring basis also fall under the fixed costs category. If you’re renting a commercial space for your business, then the rent amount counts as a fixed cost as well.
If you have taken out a business loan, or are leasing equipment or machinery, then you’ll need to make monthly payments. Those expenses factor into your list of fixed costs as well. Another way you can consider protecting your business is with public liability insurance. Learn more about how public liability insurance can help you protect your business.
What Are Variable Costs?
Your variable costs can have a direct impact on your net income, as it’s dependent on your production volume and sales. Variable costs are those costs that are related to procuring, producing or manufacturing products or services.
If your business is involved in producing and selling clothes, then you’ll need to procure the raw material that goes into making those clothes. You’ll also need to factor in labor costs, packaging costs, shipping and transportation costs, and more.
These expenses can vary from month to month. During some months, you may find a higher demand for your products or services. Around this time, your net income is also bound to increase as a result.
When it comes to variable costs, you have a degree of control over your expenses. You can actively choose to amp up or reduce production volume. You can also choose to negotiate with vendors to secure a better price for your raw materials.
Utilities, which can change from month to month, depending on energy and water use, also count as variable costs.
What Are Semi-Variable Costs?
Semi-variable costs are those that have features of both fixed and variable costs. The most prominent examples of semi-variable cost are employee bonuses.
If your business provides performance bonuses to employees, then you may have to pay them a different amount as a bonus each month. You can also remove performance bonuses from your pay structure, as these aren’t fixed. This changes the amount you have to pay each month, but since bonus payments happen on a regular basis, that makes them fixed as well. Whether you pay performance bonuses monthly, quarterly, or annually, they count as semi-variable costs.
Business owners who hire workers on a commission basis will also need to consider salary commissions. Salary commissions, much like bonuses, can vary from month to month, depending on how well the employee performed that month. These also fall under the category of semi-variable works.
How Do Fixed and Variable Costs Affect Net Income?
Your net income is the sum you have left after all your business expenses have been dealt with. This includes expenses related to fixed as well as variable costs. If you don’t monitor and manage your fixed and variable costs, you may end up with little to nothing as profit.
To understand what your net income is, you first need to calculate how much you need to make every month to break-even. Your break-even point should take into account the amount you need to comfortably run your business. These costs include your rent, overhead, wages, and more. Consider this your fixed costs for the month.
On top of your break-even costs, you’ll then need to factor in how much you’re spending on your production volume. This should take into account how much consumer demand there is for your products and services. If there isn’t demand during a particular month or period of time, you can actively lower your production volume to protect your net income.
You should also consider your sales targets as well as your profit margin. While you can’t control your fixed costs, you can manage your variable costs to boost profits. To do this, you’ll first need to calculate what your variable costs are. This is done by multiplying the total number of products or services, by the production cost of one unit of that product or service.
Your net income then becomes what’s left of your monthly income and expenses, after all your other business expenses have been settled. If you don’t pay attention to your fixed and variable costs, you run the risk of losing money, especially through variable costs.
Conclusion
Different industries have different business costs. What works for a real estate business may not work for a construction company. If you want to understand what the fixed and variable costs related to your industry look like, a competition analysis can give you your answers.
Understanding what your business costs are allows you to protect your finances and boost business income.
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