Producing goods and services will result in firms experiencing different types of costs. Fixed costs are one type common among the majority of manufacturing firms. A fixed cost does not change as a company increases its production output. The company will pay the same amount of money for each production batch run through the company’s manufacturing process. A few stark advantages exist with fixed costs.
Fixed costs will remain stable throughout a company’s production process. Once a company purchases and installs a machine, for example, the production set-up costs always remain the same. Fixed costs are easier to account for as costs do not change relative to the volume of goods produced. This is the complete opposite of variable costs, which can experience multiple price variances. For example, variable costs are subject to price increases related to low supply.
While total fixed costs will not decrease with increases in production volume, per-unit fixed costs will decrease. For example, a company produces 1,000 widgets using a machine. The set-up cost for the machine is $3,000. Fixed costs allocated to each individual product are $3 per unit. If the company increases production output to 1,500 widgets, the per-unit fixed costs decrease to $2. This is not always the case with variable costs.
Production output and fixed costs typically remain the same for a relevant range of output. For example, a company can produce between 1,000 and 2,000 widgets without experiencing an increase in fixed costs. This allows for multiple production output estimates as fixed costs are easy to calculate for any output between 1,000 and 2,000 units. A disadvantage, however, is the increase in per-unit fixed costs when a company operates at the lower range of its production output.
Increases Period Expenses
Most companies with fixed costs have depreciation associated with production equipment or facilities. Depreciation lowers a company’s net income for each accounting period. The increase in period expenses will reduce a company’s tax liability, resulting in cash savings for the useful life of fixed assets. When a company disposes of old production equipment, a loss on the sale of equipment can also decrease net income and result in tax liability savings.
- "Cost Accounting"; Ronald W. Hilton, et al.; 2006