Not all costs behave the same way. Some costs -- variable costs -- fluctuate with production levels. Other costs -- fixed costs -- do not. Being able to identify which costs are fixed and which are variable can help your business analyze its cost structure and predict future costs at different activity levels.
Fixed Costs Fixed costs are business costs that do not vary at different production or sales levels. The underlying concept of fixed costs is that a company could cease production and still incur these costs. Common fixed costs for a company are administrative salaries, benefits, rent, depreciation, property taxes and insurance. Fixed costs tend to be consistent month by month, though they can change occasionally. However, the change in the expense isn't directly correlated to the activity level of the business. For example, property taxes might rise due to a higher assessment, or rent could increase based on inflation.
Calculating your fixed costs is a simple matter of adding up all fixed costs incurred during the year. To calculate fixed costs per unit, divide total fixed costs by the number of units produced. For example, if total fixed costs are $500,000 and the company produced 250,000 units during the year, fixed costs are $2 per unit.
Unlike fixed costs, variable costs fluctuate based on the company's level of production or sales. Common variable costs are direct materials, production supplies, shipping, credit card fees and sales commissions. Variable costs per unit tend to stay consistent, but can change due to an economy of scale. For example, if a business gets a better deal on bulk orders of raw materials, variable costs per unit may decrease after a certain production level.
To calculate total variable costs, sum all of these costs incurred during the year. To calculate variable costs per unit, divide total variable costs by the number of units produced. For example, if total variable costs are $750,000 and the company produced 250,000 units during the year, fixed costs are $3 per unit.
Some costs don't fall neatly into the variable or fixed categories. Certain costs -- like phone, electricity, gas and water costs -- have both a fixed component and a variable component. That means the company is charged a base fee no matter what and an incremental fee based on usage.
There are a few methods companies can use to split mixed costs into variable and fixed costs. If the bills are detailed enough and there's only a few transactions, the company can identify how much of every month's bill is fixed and how much is variable. For larger amounts of transactions, companies can use regression analysis. In regression analysis, the analyst inputs the cost of each monthly bill, along with the production level that month, into a spreadsheet program. The regression function analyzes the data and determines the monthly fixed cost and a multiplier for variable costs.
For example, an analyst could use regression analysis and determine that annual mixed costs of $400,000 are comprised of $300,000 in fixed costs and $100,000 in variable costs. If the company produced 250,000 units that year, mixed costs add $1.20 per unit in fixed costs and 40 cents per unit in variable costs.