How to Calculate Fixed Cost
Make a list of all costs over a period of time., Separate your fixed costs from your marginal, or variable, costs., Look out for commonly overlooked fixed costs., Divide fixed cost by total units produced., Recognize that greater production lowers...
Step-by-Step Guide
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Step 1: Make a list of all costs over a period of time.
Commonly you use quarters (3-month periods) or years to see your expenses running a business.
If you don't already have detailed receipts and books, start making them immediately.
Save all receipts and, at least once a week, write down all of the costs that you spend in a ledger, or accounting book.
You want to note everything about the expense, including:
Amount Date spent Reason for spending If it is recurring (will you need to pay the same costs again?) -
Step 2: Separate your fixed costs from your marginal
Fixed costs don't change no matter how much you produce.
If you own a factory that makes postcards, you will pay the same amount of fixed costs if you produce 100 vs. 100,000 postcards.
Variable costs change depending on how much you're spending each day.
For example, in the postcard factory you might break down costs as:
Fixed Costs:
Rent/Mortgage for the factory, insurance, taxes, equipment maintenance, and payments.
Variable Costs:
Paper, ink, shipping to customers., Use your records to look for certain costs that you pay regularly each month or year.
Fixed costs are essential to run your business, and may raise or lower if your business gets bigger or smaller.
However, fixed costs will not change depending on how much of your product you make or sell.
Some costs can be both fixed and variable.
For example:
Labor:
You may need to hire more workers depending on how many card you make.
However, your support staff of administrative assistants, accountants, etc. will stay fixed unless you become much bigger of a company.
Permits, Taxes, etc:
You may need to pay more taxes and file for different permits depending on your business, but you will always need to pay the basic permits and taxes on your equipment, building, etc.
Maintenance and Upkeep:
You may go 6 months without having to fix anything, then suddenly need to fix the whole system.
It may feel variable, but repair costs and upkeep are inevitable in every business.
Take a look at old financial records, or average your repair costs over 12 months, and you'll notice that general upkeep is a fixed cost., This is a simple, but important metric to help you set prices and find ways to improve your business.
For example, you might have a fixed cost of $100 for your small postcard company over 1 month.
Say you produce 200 cards in that month.
This would mean that, for each card you make, it costs you $0.50 in fixed cost.
The more cards you make, the lower this gets, leading to higher profits.
This is known as "Fixed Cost per Unit."
Fixed costs are inevitable, and the only way to eliminate them is to get out of business.
You likely cannot lower them directly, but you can lower their impact by making and selling more.
This is why mass-production is considered cheaper than making small individual products.
Returning to the postcards:
Imagine that your total fixed cost is $500,000.
It costs your $0.50 in paper, ink, and labor to make each card.
If you make 500,000 cards, then each card will cost you $1 in fixed costs to make.
With variable costs (ink, paper, etc.) each card costs you $1.50 to make total.
If you sell the cards for $2.50 a piece, you'd be making $1 profit on each card.
However, if you make and sell 1,000,000 cards, suddenly you're only spending $0.50 per card in fixed cost, bringing your total cost to $1.
You're now making $1.50 in profit on each card, without having to change prices or demand for your cards.
Note that, in reality, this is not so simple.
Drastically increasing production may increase fixed costs, though variable costs may go down as well.
However, the principle of distributing fixed costs with mass-production still holds. -
Step 3: or variable
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Step 4: costs.
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Step 5: Look out for commonly overlooked fixed costs.
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Step 6: Divide fixed cost by total units produced.
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Step 7: Recognize that greater production lowers your fixed cost per unit.
Detailed Guide
Commonly you use quarters (3-month periods) or years to see your expenses running a business.
If you don't already have detailed receipts and books, start making them immediately.
Save all receipts and, at least once a week, write down all of the costs that you spend in a ledger, or accounting book.
You want to note everything about the expense, including:
Amount Date spent Reason for spending If it is recurring (will you need to pay the same costs again?)
Fixed costs don't change no matter how much you produce.
If you own a factory that makes postcards, you will pay the same amount of fixed costs if you produce 100 vs. 100,000 postcards.
Variable costs change depending on how much you're spending each day.
For example, in the postcard factory you might break down costs as:
Fixed Costs:
Rent/Mortgage for the factory, insurance, taxes, equipment maintenance, and payments.
Variable Costs:
Paper, ink, shipping to customers., Use your records to look for certain costs that you pay regularly each month or year.
Fixed costs are essential to run your business, and may raise or lower if your business gets bigger or smaller.
However, fixed costs will not change depending on how much of your product you make or sell.
Some costs can be both fixed and variable.
For example:
Labor:
You may need to hire more workers depending on how many card you make.
However, your support staff of administrative assistants, accountants, etc. will stay fixed unless you become much bigger of a company.
Permits, Taxes, etc:
You may need to pay more taxes and file for different permits depending on your business, but you will always need to pay the basic permits and taxes on your equipment, building, etc.
Maintenance and Upkeep:
You may go 6 months without having to fix anything, then suddenly need to fix the whole system.
It may feel variable, but repair costs and upkeep are inevitable in every business.
Take a look at old financial records, or average your repair costs over 12 months, and you'll notice that general upkeep is a fixed cost., This is a simple, but important metric to help you set prices and find ways to improve your business.
For example, you might have a fixed cost of $100 for your small postcard company over 1 month.
Say you produce 200 cards in that month.
This would mean that, for each card you make, it costs you $0.50 in fixed cost.
The more cards you make, the lower this gets, leading to higher profits.
This is known as "Fixed Cost per Unit."
Fixed costs are inevitable, and the only way to eliminate them is to get out of business.
You likely cannot lower them directly, but you can lower their impact by making and selling more.
This is why mass-production is considered cheaper than making small individual products.
Returning to the postcards:
Imagine that your total fixed cost is $500,000.
It costs your $0.50 in paper, ink, and labor to make each card.
If you make 500,000 cards, then each card will cost you $1 in fixed costs to make.
With variable costs (ink, paper, etc.) each card costs you $1.50 to make total.
If you sell the cards for $2.50 a piece, you'd be making $1 profit on each card.
However, if you make and sell 1,000,000 cards, suddenly you're only spending $0.50 per card in fixed cost, bringing your total cost to $1.
You're now making $1.50 in profit on each card, without having to change prices or demand for your cards.
Note that, in reality, this is not so simple.
Drastically increasing production may increase fixed costs, though variable costs may go down as well.
However, the principle of distributing fixed costs with mass-production still holds.
About the Author
William Coleman
Specializes in breaking down complex cooking topics into simple steps.
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