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.
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.. 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.. 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. ) 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.
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
- 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., other direct expenses, variable production overhead, variable selling & distribution overhead.
Fixed Cost vs. Variable Cost Comparative Table
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.
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 –