"Business is personal — it's the most personal thing in the world." Show These are famous words by Michael Scott from the TV show, The Office. And although this quote conflicts with the universal belief that business isn't personal, Michael's point of view is perfect when learning about a business's fixed costs — or those costs that don't change as a company grows or shrinks. To identify and calculate your business's fixed costs, let's start by looking at the ones you're already paying in your personal life. Then, we'll explain how a business manages its own fixed costs and review some common fixed cost examples.
What is a fixed cost?
Fixed costs are those costs to a business that stay the same regardless of how the business is performing. Fixed costs are distinguished from variable costs, which do change as the company sells more or less of its product. To better understand how fixed and variable costs differ, let's use personal finances as an example. As a single adult, your expenses would normally include a monthly rent or mortgage, utility bill, car payment, healthcare, commuting costs, and groceries. If you have children, this can increase variable costs like groceries, gas expenses, and healthcare. While your variable costs increase after starting a family, your mortgage payment, utility bill, commuting costs, and car payment don't change for as long as you're in the same home and car. These expenses are your fixed costs because you pay the same amount no matter what changes you make to your personal routine. In keeping with this concept, let's say a startup ecommerce business pays for warehouse space to manage its inventory, and 10 customer service employees to manage order inquiries. It suddenly signs a customer for a recurring order that requires another five paid customer service reps. While the startup's payroll expenses go up, the fixed cost of a warehouse stays the same. To get the full picture of what costs are associated with running your business, it's important to understand the total fixed cost and average fixed cost. Total Fixed CostThe total fixed cost is the sum of all fixed costs that are necessary for running your business during a given period of time (such as monthly or annually). Average Fixed CostKeep in mind you have to keep track of your business's fixed costs differently than you would your own. This is where the average fixed cost comes into play. Average fixed costs are the total fixed costs paid by a company, divided by the number of units of product the company is currently making. This tells you your fixed cost per unit, giving you a sense of how much the business is guaranteed to pay each time it produces a unit of your product — before factoring in the variable costs to actually produce it. The warehouse and forklift costs remain unchanged regardless of how many products they sell, giving them a total fixed cost (TFC) of $5,000 + ($800 x 2), or $6,600. By dividing its TFC by 50 — the number of units the business produced last month — the company can see its average fixed cost per unit of product. This would be $6,600 ÷ 50, or $132 per unit. How to Calculate Fixed CostTo calculate fixed cost, follow these steps:
Fixed Cost ExamplesSo far, we've identified a handful of fixed cost examples since considering the costs we already pay as individuals. A home mortgage is to a lease on warehouse space, as a car payment is to a lease on a forklift. But there are a number of fixed costs your business might incur that you rarely pay in your personal life. In fact, some variable costs to individuals are fixed costs to businesses. Here's a master list of fixed costs for any developing company to keep in mind:
Calculating your fixed costs isn't always the most fun part of growing your business. But knowing what they are, and when you'll pay each one, gives you the peace of mind you need to serve and delight your customers.
Topics: Ecommerce
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