Business planning requires breaking expenses down into fixed and variable costs. Fixed costs are consistent in any given period. Variable costs fluctuate according to the amount of output produced. If you pay an employee a salary that isn't dependent on the hours worked, that's a fixed cost. Other types of compensation, such as piecework or commissions are variable.
Annual salaries are fixed costs but other types of compensation, such as commissions or overtime, are variable costs.
Fixed Versus Variable
The difference between fixed and variable costs is essential to know for your business's future. Variable expenses are tied in to your business's productivity. The amount of raw materials and inventory you buy and the costs of shipping and delivery are all variable. The more in demand your products are, the more the costs go up. Fixed costs include rent, utilities, payments on loans, depreciation and advertising. You can change a fixed cost – move to somewhere with lower rent, for instance – but the costs don't fluctuate otherwise. Even if the economy craters and your sales drop to zero, fixed costs don't disappear.
Fixed and Variable Payroll
Any employees who work on salary count as a fixed cost. They earn the same amount regardless of how your business is doing. Employees who work per hour, and whose hours change according to business needs, are a variable expense. Piecework labor, where pay is based on the number of items made, is variable – so are sales commissions. If you must have a minimum number of employees to keep the sales office or the production line running, their pay may be a fixed cost. If you pay someone a mix of fixed salary plus commission, then they represent both fixed and variable costs.
Using the Knowledge
When you look at expanding your business, you have to look at the variable costs. For example, if you plan to grow your lunch eatery to include the dinner shift, you'll need to spend more money on staffing the restaurant at night. If you expand your production line, that may require adding factory workers. When you set staff levels, you calculate how many more work-hours you'll need to pay for, then figure how much you'll need to earn to break even. Suppose you don't think you'll get enough dinner customers to pay for the wait staff, cooks and bussers required. You can either skimp on staff, advertise to bring people in or raise prices on the evening meal.
Fixed costs are less of an issue in planning. You pay the same amount for utilities when your business is open regardless of how busy you are. Likewise, if your factory manager is on salary, the cost of employing him stays the same even if you expand production.