Basic business costs: Which are fixed costs and which are variable costs, and why is it necessary to distinguish between them?

Effective business management involves classifying costs into two main categories: fixed costs and variable costs. This is an essential foundation. Differentiating these types of costs not only helps managers make decisions about pricing and sales targets but also serves as a key to long-term financial planning, profit control, and assessing the business’s competitiveness.

Which are fixed costs and which are variable costs - Understanding the differences

Fixed Costs (Fixed Cost) have the special characteristic of being expenses that do not change regardless of whether the business produces more or less, whether prices go up or down. They must be paid in the same amount, such as financial obligations that are paid regularly.

In contrast, Variable Costs (Variable Cost) behave oppositely — they increase or decrease directly with the volume of production or sales. The more you produce, the higher the variable costs; the less you produce, the lower they are.

Which are fixed costs - characteristics and detailed examples

Fixed costs are predetermined and do not change with increases or decreases in operational volume. The business must bear these expenses whether sales are good or poor.

###Common examples of fixed costs include:

Rental of production and office space — whether you sell one item or one hundred items per month, the rent remains the same according to the lease agreement.

Salaries of permanent staff — a fixed team receiving monthly wages regardless of sales volume that month.

Depreciation of assets — calculating depreciation of machinery, buildings, vehicles, or refrigerators used in production, decreasing over time according to accounting principles.

Business and asset insurance — insurance premiums paid to mitigate risks.

Interest on borrowed funds — if the business borrows money for expansion, interest payments are made regularly as per agreement.

Regular expenses — such as telephone, internet, electricity (basic parts), and other utilities with minimum charges.

Why understanding fixed costs is important

Since fixed costs are stable, businesses can forecast these expenses accurately, making budgeting and revenue projection easier. It also helps determine how many units need to be sold to break even and start generating profit.

Variable costs - main components related to production volume

Variable costs are more flexible because their amount depends on how much the business produces or sells. When sales increase, these costs rise proportionally; when sales decrease, they fall accordingly.

###Main components of variable costs:

Raw materials and components — for example, if you produce candies, ingredients like sugar, milk, and coloring depend on the number of candies to be produced.

Direct labor — production line workers hired as needed; if production volume increases, wages increase.

Production energy costs — electricity, fuel, gas used to operate machinery; the more you produce, the higher the energy consumption.

Packaging materials and boxes — packaging used to wrap or contain products, varying with the number of items sold.

Transportation and delivery costs — costs for shipping products to customers; more sales mean higher transportation costs.

Commissions — payments to sales agents or other bonuses based on sales volume.

Effective management of variable costs

Controlling variable costs to lower levels is a key way to increase profit. Businesses can negotiate with suppliers for better raw material prices, invest in modern machinery to reduce waste, or improve manufacturing processes for greater efficiency.

In-depth comparison: Fixed costs vs. variable costs

Total costs: combining both types

Total Cost (Total Cost) = Fixed Costs + Variable Costs

Example: Ice water shop

• Monthly fixed costs: rent 15,000 THB + manager salary 8,000 THB = 23,000 THB
• Variable cost per unit: raw materials 20 THB + packaging 5 THB + direct labor 5 THB = 30 THB per unit

If this month sells 1,000 units:

• Total variable costs = 1,000 × 30 = 30,000 THB
• Total costs = 23,000 + 30,000 = 53,000 THB

Next month, if sales reach 1,500 units:

• Total variable costs = 1,500 × 30 = 45,000 THB
• Total costs = 23,000 + 45,000 = 68,000 THB

Note that fixed costs remain unchanged, but total costs vary.

Using cost analysis for decision-making

1. Pricing strategy

Ensure that the selling price covers both fixed and variable costs plus profit. For example, if the total cost per unit is 50 THB, you might set the selling price at 80 THB to earn a 30 THB profit.

2. Sales volume planning (Break-even Analysis)

Calculate the number of units needed to cover fixed costs and start making a profit using the formula:

Break-even units = Fixed Costs ÷ (Selling Price - Variable Cost per Unit)

3. Investment decisions

Before investing in new machinery (which is a fixed cost), analyze how much it can reduce variable costs and how many years it will take to recover the investment.

4. Cost control and profit enhancement

• Reduce fixed costs: negotiate rent, reduce permanent staff
• Reduce variable costs: find cheaper suppliers, improve production efficiency

5. Competitiveness analysis

Businesses with high fixed costs need higher sales to be profitable. Those with high variable costs must focus on efficient production management.

Summary: Which are fixed costs and why are they important for business

The difference between fixed and variable costs is not just about accounting classification but is a managerial tool that helps managers make informed decisions.

Fixed costs must be paid regardless of whether the economy is good or the market is poor. Understanding which costs are fixed allows for better long-term planning.

Variable costs are flexible; businesses can reduce them when sales decline or increase them to meet higher demand.

Managing both types of costs wisely helps businesses build financial stability, enhance competitiveness, and generate sustainable profits in the long run.