Fixed Costs
Fixed costs are the costs of running a business that are not dependent upon the amount of output produced. Fixed costs are incurred irrespective of the volume of production and sales, and vary little with minor changes in sales volume. They are most common in industries with high capital investments. Fixed costs include items such as rent, depreciation, interests, insurance, and administrative expenses.
Rent: Rent is the most common form of fixed cost for businesses. Rent for a set period of time is often paid in advance at the beginning of the lease period. Rent may be due on a monthly, quarterly, or periodic basis, depending on the agreement with the lease provider.
Depreciation: Depreciation is the process of reducing the value of an asset over its useful life. Companies need to expense depreciation annually to take account of the cost of maintaining an asset. This is an example of a fixed cost because it is not related to the production volume of the business. In most cases, depreciation is calculated using standard accounting protocols, such as the straight line method, declining balance method, or sum of the years digits method.
Interests: Interest payments represent a fixed cost in businesses because they are usually payable regardless of the amount of output that is produced. This cost is a portion of the total loan amount that is paid to the lender in interest for the loan. Interest payments on loans can be fixed amounts each period or variable, depending on the terms of the agreement with the lender.
Insurance: Insurance is a cost that is often associated with fixed costs. Companies pay premiums on a periodic basis to ensure they are covered in the event of accidents or damage to their property. The premiums are usually fixed and do not vary with changes in the volume of production.
Administrative Expenses: Administrative expenses are an important component of fixed costs for businesses. This includes costs for things like office supplies, staff wages and salaries, travel, and professional services. All these items are necessary for a business to operate efficiently and can amount to a significant expense.
Conclusion
Fixed costs are a necessary component of any business as they help a company manage its budgeting and ensure that it can meet its obligations regardless of its output. Although fixed costs are unavoidable, it is important for businesses to review their fixed costs regularly to ensure that they are not overpaying for items or for services that are not needed. By carefully monitoring the fixed costs of a business, companies can reduce their overhead and increase their profitability.
