Fixed vs. variable costs: What are the differences?

Business costs are an unavoidable component of launching and running your own company. But understanding how different costs factor into your overall financial strategy can play a key role in long-term success. Two types of business expenses are fixed and variable costs. Understanding how they compare can help you make more informed decisions and can lead to more accurate budgeting and forecasting.

Read on to learn about the differences between fixed and variable costs. 

What you’ll learn:

• There are two types of business expenses: fixed costs and variable costs.

• Fixed costs generally remain the same despite production levels, whereas variable costs fluctuate depending on how much your company produces. 

• You can minimize your business’s fixed costs by lowering lease or mortgage payments, looking for better vendor pricing and comparing rates on insurance premiums and loans.

• Understanding your business’s fixed and variable costs can help with budgeting and forecasting so you can make smarter financial decisions as you grow your company.

Fixed costs refer to business expenses that generally stay the same regardless of how much your company produces. These costs are predictable and often already calculated in your business’s budget. Fixed business costs are typically paid on a monthly or an annual basis. 

Examples of fixed costs include:

• Rent

• Insurance

• Property tax

• Depreciation

Variable costs are business expenses that vary depending on the amount of goods and services your company produces. This means if your production volume increases, your business’s variable costs also increase. By contrast, if your production volume decreases, your business’s variable costs will also decrease. 

Examples of variable costs generally include:

• Raw materials

• Hourly labor

• Utilities

• Transaction fees

• Commissions and bonuses

To reduce fixed costs, start by identifying your recurring expenses and looking for opportunities to lower, renegotiate or eliminate them. You can estimate your business’s fixed costs by adding up recurring expenses, such as monthly or annual payments. If, after calculating your fixed costs, you decide you should cut back, a good next step is to consider different cost-reduction strategies, like:

• Lower facility-related payments: If mortgage or rental payments are eating into your budget, you might look for other options to lower your occupancy costs. For example, you could try negotiating your current lease, relocating to a lower-cost area or subleasing some of your existing space to recoup a portion of your monthly operating expenses. If possible, you may also consider switching to a remote setting to completely cut out facility-related costs.

• Shop around for better pricing: There are a variety of business costs that could be influenced by market rates, like vendor prices, insurance premiums and loan rates. To reduce fixed costs, you could compare different options to ensure you’re getting fair and competitive pricing. 

• Decrease labor costs: If you have funds tied up in excess payroll, you might choose to reassess staffing. Layoffs may not be the ideal solution—especially if they impact morale and long-term retention—but they can be necessary to keep operations afloat. As an alternative to layoffs, you might consider other ways to reduce labor costs, like scaling back shifts, hiring entry-level talent or offering internships.

• Refinance existing debt: If you’re making monthly payments on business debt, you could shop around with different lenders to potentially secure a lower interest rate. This could lead to lower monthly fixed costs.

To budget for variable costs, proactively managing and monitoring fluctuating expenses over time can be a good business practice. Because variable costs fluctuate, it can be hard to forecast exact expenses. Here are a few strategies you can use:

• Build a buffer: By setting aside a cash reserve, you can help maintain financial stability during periods of uncertainty. Many experts recommend keeping three to six months’ worth of business expenses on hand to account for revenue fluctuations. 

• Track costs over a set period of time: Review your business’s variable expenses over a few months to see whether there are any patterns. Comparing your variable costs to production levels can make it easier to predict higher-cost periods and plan ahead.

• Try 50/30/20 budgeting: There are a variety of budgeting frameworks you can use to help you anticipate and account for variable cost fluctuations. One approach, adapted from the 50/30/20 rule commonly used in personal finance, is to allocate 50% of business revenue to fixed operating costs, 30% to variable expenses and 20% to profit or future growth.

• Consider zero-based budgeting: Another framework that can be particularly helpful for managing variable expenses is zero-based budgeting. With this approach, you start from zero at the beginning of each budgeting period rather than basing your budget on the previous period’s spend. This lets you tailor your budget to current needs while supporting spending that scales with revenue.

Expense management is important for small-business owners because it can help you identify opportunities to cut costs. In turn, this could lead to increased profitability. Tracking your business’s expenses can also give you deeper insights into your company’s financial trends. This can support budgeting efforts and help you make more informed decisions about cost management and future investments.

Understanding how your business’s fixed and variable costs impact your bottom line is important for effective financial planning. While fixed costs generally don’t change based on output, variable costs fluctuate as production increases or decreases. Once you know your company’s fixed and variable costs, you can better forecast expenses and find ways to manage your business’s cash flow.

One tool you can use to help with cost-tracking is a business credit card. Capital One offers a variety of business card options that can help support your company’s unique needs. You can find out whether you’re pre-approved today—without negatively impacting your credit scores.