Why are fixed costs and variable costs important variables that businesses need to understand deeply?

Every company faces a complex cost structure, whether a startup or a large corporation. Analyzing which expenses are variable and which are fixed is fundamental to a rational business strategy. Prudent cost management enables companies to adjust pricing formulas, optimize production, and accurately determine the break-even point, thereby strengthening stability and creating room for growth in uncertain market conditions.

Fixed Cost (Fixed Cost) — What It Means and Why It Affects Financial Strategy

Fixed costs refer to business expenses that do not change with variations in production volume or sales revenue. Whether a company operates at high or low levels, these costs continue to incur. This is why, when sales suddenly decline, a company can still face severe financial problems because fixed costs must be paid regardless of profit margins.

Understanding the fixed cost structure allows management to plan investments carefully, including estimating the minimum cash flow needed to keep the business running. This knowledge plays a crucial role in maintaining financial stability.

Key Characteristics of Fixed Costs

Stability regardless of economic expansion or contraction Fixed costs remain consistent, unlike variable costs that change with activity levels. For example, if a factory pays 100,000 THB in rent monthly, the company must pay this amount whether it produces 1,000 or 10,000 units.

Impact on Break-even Point Fixed costs are essential in calculating how many units of goods or services a company must sell to break even (Break-even point). When fixed costs are high, the break-even point will also be high, meaning the company needs sufficient sales capacity.

Examples of Fixed Costs Companies Must Face

Fixed costs cover many aspects of business operations. Recognizing these helps companies plan budgets effectively:

• Rent and Office Buildings – The company pays monthly rent regardless of business performance.

• Management Salaries – Senior executives and support staff receive fixed salaries throughout the year.

• Depreciation of Fixed Assets – When a company purchases machinery or equipment, its value decreases annually, and depreciation is accounted as a fixed cost.

• Business Insurance – Costs for risk mitigation that must be paid regularly.

• Loan Interest – When borrowing funds, interest payments are due as per agreement, even if the business is unprofitable.

Prudent management of fixed costs allows companies to make sustainable investment decisions, considering whether they can bear these ongoing expenses.

Variable Cost (Variable Cost) — Understanding the Other Half of the Equation

Variable costs refer to expenses that fluctuate proportionally with production or sales volume. As a company produces more goods, variable costs increase accordingly. Conversely, if production decreases, these costs decrease as well.

The nature of variable costs provides flexibility; if sales are low, a company can reduce production and related expenses, unlike fixed costs that remain regardless of sales volume.

Practical Characteristics of Variable Costs

Direct relationship with production volume Variable costs rise or fall with changes in output, allowing companies to control short-term expenses effectively.

Cost per unit calculation When a company knows the variable cost per unit, it can set prices and estimate profits. For example, if the variable cost per unit is 50 THB, the company might price it at 150 THB per unit to cover fixed costs and generate profit.

Common Types of Variable Costs Monitored Regularly

• Raw materials and components – Costs for purchasing materials used in production; higher production increases these costs.

• Direct labor wages – Wages for workers directly involved in manufacturing, often paid based on output.

• Packaging and wrapping materials – More units produced require more packaging materials.

• Electricity, water, and energy – Operating costs that increase with production volume.

• Transportation and delivery costs – Higher production leads to higher shipping expenses proportionally.

• Sales commissions – Sales teams and agents often earn commissions based on sales performance.

Managing variable costs requires continuous monitoring to ensure that gross profit margin (Gross Profit Margin) remains sufficient.

Comparing Cost Structures: Fixed vs. Variable

Distinguishing between fixed and variable costs is not just theoretical but critically practical for business decision-making. For example, a company might consider whether investing in automation (increases fixed costs) is justified if it significantly reduces variable labor costs.

Cost stability: Fixed costs remain constant over time, while variable costs change with operational levels.

Financial planning challenges: Businesses with high fixed costs need higher sales volumes to break even, whereas those with high variable costs are more flexible but may face difficulties in cost control.

Business model choices: Companies must decide on the optimal balance between fixed and variable costs.

Analyzing Total Costs and Leveraging for Decision-Making

Combining fixed and variable costs provides an overall picture of total costs (Total Cost), which informs various decisions:

• Pricing products: Set prices high enough to cover total costs and generate profit.

• Break-even analysis: Calculate the sales volume needed to cover all costs.

• Sensitivity analysis (Sensitivity Analysis): Forecast how a 20% decrease in sales impacts profits.

• Investment decisions: When evaluating new projects, analyze additional fixed costs and per-unit variable costs.

The Importance of Understanding Costs

Fixed and variable costs are like two gears of a business machine. Fixed costs provide stability but require careful management, while variable costs offer flexibility but demand ongoing oversight. Understanding both roles enables companies to develop appropriate cost strategies, streamline operations, and sustainably increase profits. Companies that excel in cost management and analysis are more likely to survive and thrive in changing market conditions.