If you are an investor, a business owner, or a freelancer, it might be helpful for you to understand the difference between fixed and variable expenses. This will help you better understand your company’s finances, how it allocates its resources, and whether or not it is meeting its goals. In every business, a large portion of the budget is made up of these expenses, so it’s essential to understand what each one means, how much it is likely to cost you, and how much of a difference each will make to your bottom line.
- Fixed Expenses
Fixed expenses are those that do not change based on the demands of the business. Instead, these expenses remain the same no matter how much you sell. So, if you run a company mainly centered around selling a particular product or service, your fixed costs are necessary to produce the product or service. These may include the cost of keeping your lights on, keeping your offices stocked with the tools and equipment required to turn out a product, and even paying employees. All these expenses need to be covered as a part of running any company, but they will not increase or decrease no matter how much money you make.
- Variable Expenses
Variable expenses are those that are based on how much money you make. For example, suppose you have a business centered around selling a particular product or service. In that case, you usually incur some expenses that will vary based on how many products are sold. A company selling a product would need to pay their employees no matter how many people buy the product, but their wages may rise or decline depending on how well they’re doing. On the other hand, a company selling service will have expenses such as office rent, travel expenses, and inventory that all increase or decrease based on what is being sold. When overestimate your variable costs, you must consider the number of sales you anticipate. A mistake many makes is applying a percentage of expenses to their sales, which can result in millions as a company loses money on every sale.
- Balanced Approach to Different Expenses
Both fixed and variable expenses are essential aspects of your budget, but it is important to consider how much money you need for each expense category. If you need more funds for fixed costs, your business will not grow as rapidly, and you will be able to afford fewer employees.
A balanced approach to expense planning will help you achieve the profitability you want while keeping necessary expenses alone. It is essential to consider your current fixed costs, how much room you have for additional investments, and how much your variable prices will likely vary with any changes in profit. Remember that even if sales are down a little, it may be wise to hold off on any investments that aren’t necessary because if sales pick up again, it will leave you without room for expansion.