What Are Fixed Expenses and How Do They Affect Your Business’s Finances?
The good news is, if you understand what fixed expenses are, how to manage them, and how they affect your business, you’ll also understand variable expenses. In this post, we’ll be discussing everything you should know about fixed expenses, so that you can better manage your finances
Everything You Should Know About Fixed Expenses:
Understanding Fixed Expenses vs. Variable Expenses
As mentioned, accountants generally think of fixed expenses in relation to variable expenses. This is because it’s easier to evaluate a business from a strategic perspective when you categorize expenses into fixed and variable.
Fixed expenses stay the same over a given period and are considered necessities. Examples of these types of expenses include insurance, rent, utilities, salaries, or interest expense. Since these are fixed-price necessities, these costs are generally harder to reduce.
Variable expenses, on the other hand, fluctuate when sales volumes or production levels change. For a small manufacturer, an example of a variable expense is a cost that increases as the number of products manufactured increases.
How Fixed Expenses Affect a Small Business
Put simply, fixed expenses can make or break your small business’s finances. After all, these are the expenses that you’ll have to pay for even when you’re not making any sales. That means, when times are tough and you’re not generating much revenue, you’ll still need to cover your fixed expenses. If you can’t cover these expenses, your business will go under.
On the flip side, low fixed expenses can be the key to your success. For example, a store that only sells goods online may have relatively low fixed costs. Since they have no need for a physical storefront or workforce to run that store, they can usually handle higher variable costs than a brick and mortar store can.
How to Manage Fixed Expenses
The key to managing fixed expenses is to evaluate them over the long term because, despite their name, fixed expenses don’t remain fixed forever. Whether an expense is fixed or not depends on the timeframe in which you’re evaluating that expense.
For example, if you’re evaluating the cost of a year-long office lease over a six-month timeframe, the monthly expense of that lease is considered a fixed expense. However, that same year-long office lease is considered a variable expense when evaluated over a five-year timeframe. This is because your company may need a larger office after five years of growth, or perhaps you need to downsize due to a strategic pivot.
Either way, by characterizing fixed expenses in this way, you’ll be able to make an informed decision based on the long-term needs of your business. When you do this, you put yourself in the best position to manage your fixed expenses.
Of course, you can also look for easy opportunities to manage fixed expenses by renegotiating existing contracts. It may also be worthwhile to review your fixed expenses to see if you should look for new vendors, locations, or systems that could lower expenses in the future.
Conclusion: Consider Your Fixed Expenses
There will always be a limit on how much you can lower your business’s fixed expenses. In addition, lowering your fixed expenses at the cost of quality can end up costing you more than you save. For example, if you run a retail store and try to lower your expenses by moving to a low-rent shopping district, your sales volume could take a large hit that’ll cost far more than the money you saved in rent.
Therefore, it’s important to recognize that your business is unique, and your fixed costs are an investment in your business. Ultimately you should focus on doing what you can to reduce expenses, but only to the extent that it helps you achieve your business goals.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.