Fixed expenses are costs in a budget or financial statement that stay the same throughout the year. Examples of fixed costs include rent, property tax, and insurance. When an expense doesn’t remain constant throughout the year, it is called a variable expense. Keeping track of spending is a necessity for all businesses, so fixed expenses apply to all businesses. They are also used by the everyday person who maintains a budget for their personal spending. Rent and cell phone bills are usually fixed costs in personal finances. Continue reading for a better understanding of what fixed expenses are, how to determine what they are in your business, and how they help your business.
What Are Fixed Expenses?
As defined by Accounting Coach, a fixed expense is “an expense that will be the same total amount regardless of changes in the amount of sales, production, or some other activity.” They must stay the same within a reasonable or relevant range of activity. For example, rent stays consistent each month, but if your business grows so large that you no longer have space for necessary inventory or to hire new employees, your rent will increase because you need to rent more space.
Who Uses Fixed Expenses?
Fixed expenses are used by business owners, entrepreneurs, accountants, financial advisers, and people who create budgets for their personal finances. It really should be used by everyone, whether on a personal or business level, in order to effectively manage spending. Business owners and entrepreneurs use fixed costs to help estimate how much they’ll spend each month. Fixed expenses are used to create budgets in both business and personal lives.
Accountants, financial advisers, and others in the finance industry pay attention to fixed expenses as well to correctly assist their clients and improve their finances. Sometimes one of these costs could be reduced. Being aware of fixed costs will also give you an idea of when they will change, so you can be prepared in advance. They may change by going away, such as when you pay off a mortgage or they may increase if you obtain additional space for the business.
How to Determine Fixed Expenses
Pick a time period over which to calculate your fixed expenses. For example, you can consider your fixed costs for a year, six months, or a financial quarter. Then, write down all of the expenses your business had over the past year, six months, or whatever time period you have chosen. Go through your list and cross off any expense that is variable. Examples of fixed expenses are:
- Equipment maintenance;
- Internet service;
To calculate your projected fixed costs, you can use the formula Fixed Cost = Cost + Depreciation + Interest on Investment + Insurance and Taxes. This formula is good for finding out how much you’ll pay in the future on fixed costs. It can also be used to estimate how much your equipment will be worth in the future, a helpful number to know if you are planning to sell your business.
Ways in Which Fixed Expenses Can Help Your Business
1. Fixed Expenses Can Help a Break-even Analysis
A break-even analysis calculates the level of production and sales in which a business breaks even. It is helpful to know at what point your business makes neither a profit nor a loss because some startups operate at a loss for the first few months or year before they hit the break even point, then move on to finally generating profits. Knowing your estimated break-even point will help you manage your business finances better and stay in business.
2. Knowing What Your Fixed Costs Are
This will help you notice when you have achieved “economies of scale”, which is a cost advantage that results from increased output. Increases in production are generally correlated with decreases in fixed costs per item. For instance, a $50,000 lease over 50,000 items is $1 in fixed costs per item. If 100,000 items are produced, then the fixed cost per item drops to $0.50.
3. Balancing Net Income/Loss
Another way fixed expenses help your business is it’s a factor in calculating the company’s net income or net loss. You want to have a net income, not a net loss, because a net income is positive. This number is calculated by subtracting expenses and losses from revenues and gains. It’s important to know your company’s net income or net loss because this factor is an indicator of the business’s financial health. In addition, net income or loss is reported on an income statement, which is one of the financial documents potential investors look at when you seek capital.
4. Finding the Source of Your Financial Struggles
High fixed expenses can make a business struggle tremendously. If you don’t know what your fixed expenses are, then you’re not even aware of why your business is going through financial hardship. By examining your fixed expenses, you can determine whether or not they’re too high. You can also search for opportunities to cut expenses. Once fixed expenses are as low as they can possibly be for the business to stay afloat, they can’t be reduced, so you must manage your finances well and ensure you always have enough money to cover fixed costs each month.
Fixed expenses stay the same regardless of how much your business produces. They may increase or decrease when your business size changes, but they stay the same for months at a time and are therefore very predictable. Fixed expenses are used to calculate several important integers for your business, such as the break-even point and fixed cost per unit.
If your fixed costs are too high, your net income and income statement will be negatively affected. The most dangerous part of not knowing your fixed expenses is being unable to cover the costs for the month. This can put you out of business because fixed expenses are usually the most important things you need, such as rent for the building and maintenance of equipment needed to make products.
Are you unsure of whether or not a particular expense in your business is a fixed or variable expense? Let us know in the comments and we’ll clarify for you in order to help you accurately calculate the fixed expenses for your business.
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