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 very important terms is the cost which means the cost of production of goods or services. Now, the cost of production can be classified 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 of time and it doesn’t depend on the level of activity or output. It can be considered a sunk cost. One of the most popular examples is depreciation which is charged on the fixed assets of a company. Now, the amount of depreciation remains constant (considering the straight-line method) 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 charge and material cost. Now, the total labor charge or the total raw material is solely driven by the level of production.
Fixed Cost vs Variable Cost Infographics
Let’s see the top differences between fixed vs variable cost.
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 to be depreciated over 10 years, so the annual depreciation charge will be USD 100. Now, if the company produces 10 units then 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
Key Differences
- Fixed cost is that cost which remains constant at gross level regardless of the volume of production, while the variable cost is that cost which changes at gross level with the level of production.
- Fixed cost is time-related as it changes only after a certain period of time, while the variable cost is volume related as it changes with the volume of production.
- Fixed cost is required to be paid irrespective of the fact whether there is any product or not, while the variable cost is only incurred 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 cost, other direct expenses, variable production overhead, variable selling & distribution overhead.
Fixed vs Variable Cost Comparative Table
| Basis for comparison | Fixed cost | Variable cost |
| Nature | It changes only after a certain period of time | It changes with the volume of production |
| Gross level | It is fixed at the gross level | It increases at gross level with the increase in production and vice versa |
| Unit level | It decreases at a per-unit level with the increase in production and vice versa | It is fixed at the per-unit level |
| Effect on profitability | The higher level of production reduces the fixed cost per unit which improves profitability | The level of production doesn’t impact per unit cost and as such no impact on the profitability |
| Risk associated | It is usually capital intensive in nature and as such exposed to risk if adequate production level is not achieved | It increases with the level of production at a constant rate and is the cost is measured at the unit level |
| Level of control | Fixed cost can’t be controlled and has to be paid | The variable cost can be controlled by controlling the volume of production |
| Contribution margin | It is not considered during the calculation of contribution margin | Contribution margin is calculated by deducting variable cost per unit from selling price per unit to ascertain the profitability of a product (higher the contribution better the product) |
| At Zero production | Fixed cost is incurred even if there is no production | No variable cost is incurred 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 can be seen from the above explanations that both the categories of cost are very different in nature and serve important 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 important 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 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 –
