## Variable Costs vs Fixed Costs - Why Businesses Need to Distinguish Clearly

The hidden danger in many business management practices is not understanding where the money is going. Most often, this stems from failing to clearly differentiate between fixed and variable costs. If you understand this difference well, you can set prices, plan production, and forecast profits more accurately.

## What Are Variable Costs - They Change with Production Volume

**Variable costs** are expenses that naturally increase or decrease depending on your production or sales volume. The more you produce, the higher these costs become; they decrease when production contracts.

What you need to understand is that **variable costs** do not depend on management decisions but are directly proportional to the quantity of goods produced.

### Real-life examples of variable costs

**Raw materials and components** - If you produce pizza, the more you make, the more flour, cheese, and other ingredients you need to buy. If today’s sales are slow, raw materials are also wasted.

**Direct labor wages** - Salaries for full-time employees are fixed costs, but additional temporary workers hired according to production shifts are variable costs.

**Energy costs** - When machinery works harder to produce more goods, energy consumption increases.

**Packaging and shipping costs** - The more products you have, the more boxes and shipping costs are incurred.

**Commissions** - Sales teams earning bonuses based on sales volume will see costs increase as sales grow.

## What Are Fixed Costs - They Remain Constant Regardless of Production

**Fixed costs** are expenses you pay whether or not you produce anything. They are like the business’s customs duty — paid every month whether the store has customers or not.

Fixed costs play a crucial role in financial planning because they indicate the "minimum" revenue needed for the business to break even.

### Examples of fixed costs businesses face

**Rent** - Whether sales are high or low this month, rent must be paid in full.

**Employee salaries** - Full-time staff working continuously must be paid monthly, even during slow sales months.

**Insurance** - Asset insurance, health insurance for employees, and general liability insurance all require regular payments.

**Loan interest** - If you borrowed money initially to start the business, interest must be paid regardless of profit or loss.

**Depreciation** - Equipment, machinery, buildings, and vehicles depreciate over time, recorded in your accounts whether they are in use or not.

**Membership fees, system, software** - Bank account fees, POS software, subscription notices, are ongoing due to long-term contracts.

## What Is the Difference - Why It’s Important to Distinguish

| Aspect | Fixed Costs | Variable Costs |
|--------|--------------|----------------|
| **Change** | Do not change with production volume | Change directly with production volume |
| **Flexibility** | Cannot be reduced in the short term | Can be increased or decreased as needed |
| **Impact on Breakeven Point** | The higher, the more units you need to sell | The higher, the more you need to reduce costs |
| **Decision Making** | Requires long-term investment considerations | Can be adjusted in the short term |

Real decision-making example: Companies with high direct labor costs tend to invest in machinery to replace large variable costs, as fixed costs are more stable.

## How to Combine Both Types to Calculate Actual Total Cost

**Total Cost = Fixed Costs + (Variable Cost per Unit × Number of Units Produced)**

Knowing this formula allows you to:

- **Calculate Breakeven Point** - How many units need to be sold to avoid losses
- **Set Appropriate Selling Price** - Cover both fixed and variable costs with profit
- **Analyze Cost Areas** - Find where money is being lost
- **Make Investment Decisions** - Should you invest in machinery?
- **Adjust Production Plans** - How many units to produce for optimal efficiency

Example: Your coffee shop has fixed costs of rent and salaries = 50,000 THB/month, (fixed costs), and the cost per cup of coffee is 20 THB, (variable costs). If you sell 200 cups, total cost = 50,000 + (20 × 200) = 54,000 THB. To achieve a 30% profit, you need to sell 300 cups.

## Practical Techniques for Controlling Both Cost Types

**For Fixed Costs:**
- Negotiate more flexible lease agreements
- Avoid hiring full-time staff; consider freelancers
- Reduce software expenses by choosing appropriate packages

**For Variable Costs:**
- Negotiate with suppliers for better raw material prices
- Improve production processes to use less energy
- Minimize waste of raw materials

## Summary

Understanding the difference between **variable costs** and fixed costs is fundamental to sound business management. Knowing which costs are fixed and which are variable helps you determine how much you need to sell to break even and make smarter investment and production decisions. It all depends on what problems your business faces and where to cut costs for maximum impact.