Fixed Cost vs Variable Cost

Difference Between Fixed Cost and Variable Cost

Fixed cost that refers to the cost that has to be payable no matter there is any production or sale activity in the business or not like rent payable, salaries payable and other utilities payable, whereas, Variable cost refers to the cost that varies with the production of goods & services that increase with the increase in production and vice versa like direct material, direct labor, etc.

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In finance and economics, one of the critical terms is the cost, which means the cost of production of goods or services. Now, the cost of production can classify into two major categories based on its nature, namely, fixed cost and variable cost.

• Fixed cost, as the name suggests, is fixed in nature during a certain period, and it doesn’t depend on the level of activity or output. It can be considered a sunk costSunk CostSunk costs are all costs incurred by the firm in the past with no hope of recovery in the future and are not considered while making any decisions since these costs will not change regardless of the decision's outcome.read more. One of the most popular examples is depreciation, which is charged on the fixed assets of a companyFixed Assets Of A CompanyFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples.read more. Now, the amount of depreciation remains constant (considering the straight-line methodStraight-line MethodStraight Line Depreciation Method is one of the most popular methods of depreciation where the asset uniformly depreciates over its useful life and the cost of the asset is evenly spread over its useful and functional life. read more) during the years of operation irrespective of the volume of production.
• On the other hand, the variable cost is directly proportional to the level of output or volume of production. A few of the popular examples are labor charges and material costs. Now, the level of production solely derives the total labor charge or the total raw material.

Fixed Cost vs. Variable Cost Infographics

Let’s see the top differences between fixed vs. variable cost.

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Example

Interestingly, fixed cost is fixed at a gross level but can come down at a per-unit level with an increase in production. Let us consider a fixed asset of USD 1000 depreciated over 10 years, so the annual depreciation charge will be USD 100. Now, if the company produces 10 units, then the depreciation charge is USD 10 per unit, while if the company produces 100 units, then depreciation per unit comes down to USD 1 per unit.

While variable cost, on the other hand, is fixed at the per-unit level but increases linearly at a gross level with the increase in production. Let us consider a labor charge of USD 10 per unit, and if the company produces 10 units, then the total labor charge is USD 100, while if the company produces 100 units, then the total labor charge is USD 1000.

• Total cost of production for 10 units = USD 1000 + USD 100 = USD 1100
• Total cost of production for 100 units = USD 1000 + USD 1000 = USD 2000

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Key Differences

• Fixed cost remains constant at gross level regardless of the volume of production. Whereas, the variable cost is that cost, which changes at a gross level with the level of production.
• Fixed cost is time-related as it changes only after a certain period. Whereas, the variable cost is volume related varies with the volume of production.
• Fixed cost is payable irrespective of the fact whether there is any product or not. Whereas, the variable cost incurs when there is any kind of production.
• At the unit level, variable costs remain the same, while fixed cost per unit varies. Fixed cost per unit reduces with the increase in volume production and vice versa.
• The fixed cost of production includes fixed production overhead, fixed administration overhead, and fixed selling & distribution overhead. Variable cost, on the other hand, includes raw material cost, labor costLabor CostCost of labor is the remuneration paid in the form of wages and salaries to the employees. The allowances are sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes.read more, other direct expenses, variable production overhead, variable selling & distribution overhead.

Fixed Cost vs. Variable Cost Comparative Table

Basis for comparison	Fixed Cost	Variable Cost
Nature	It changes only after a certain period.	It changes with the volume of production.
Gross level	fixed at the gross level;	It increases at a gross level with an increase in production and vice versa.
Unit level	It decreases at a per-unit level with an increase in production and vice versa.	fixed at the per-unit level;
Effect on profitability	The higher level of production reduces the fixed costFixed CostFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.read more per unit, which improves profitabilityImproves ProfitabilityProfitability ratios help in evaluating the ability of a company to generate income against the expenses. These ratios represent the financial viability of the company in various terms.read more.	The level of production doesn’t impact per unit cost and, as such, no impact on profitability.
Risk associated	It is usually capital intensiveCapital IntensiveCapital intensive refers to those industries or companies that require significant upfront capital investments in machinery, plant & equipment to produce goods or services in high volumes and maintain higher levels of profit margins and return on investments. Examples include oil & gas, automobiles, real estate, metals & mining.read more and, as such, exposed to risk if the company doesn’t achieve adequate production level.	It increases with the level of production at a constant rate and measured at the unit level.
Level of control	Fixed cost can’t be controlled and is payable.	The company can control the variable cost by controlling the volume of production.
Contribution margin	We don’t consider it during the calculation of contribution marginCalculation Of Contribution MarginThe contribution margin is a metric that shows how much a company's net sales contribute to fixed expenses and net profit after covering the variable expenses. As a result, we deduct the total variable expenses from the net sales when computing the contribution.read more	We calculate Contribution margin by deducting variable cost per unitVariable Cost Per UnitVariable cost per unit refers to the cost of production of each unit produced, which changes when the output volume or the activity level changes. These are not committed costs as they occur only if there is production in the company.read more from selling price per unit to ascertain the profitability of a product (higher the contribution better the product)
At Zero production	Fixed cost incurs even if there is no production	There is no variable cost in the case of zero production level
Example	Salary, Depreciation, Insurance, Rent, Tax, etc.	Cost of raw material, Labour wage, Sales commission/incentives, Packing expenses, etc.

Final Thoughts

As per the above explanations, both the categories of cost are very different and serve essential roles in the financial analysis. The higher volume of production results in better absorption of the fixed cost of production, which improves profitability, while variable cost per unit is instrumental in ascertaining the contribution margin at the product level. So, both the categories are used in unique ways to each other. As such, it is crucial to understand the various facets of the two to apply them successfully in a business scenario. I hope the article helps you to decipher the two cost categories.

Recommended Articles

This article has been a guide to Fixed Cost vs. Variable Cost. Here we discuss the top differences between them with an example, infographics, and comparative table. You may also have a look at the following articles –

• 4 Examples of Sunk Cost
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• Average Variable Cost Formula
• Economies of Scale vs Economies of Scope