In order to maintain proper control of a company's financial situation, it is very important to know the main concepts related to the management of the cash flow. In this article, we will present the differences between fixed and variable costs and why the need to know how to distinguish them.
What are fixed costs
In a very simple way, we can define fixed costs as those that do not undergo changes influenced by the volume of production. Despite the name, it can not be said that these costs - which can also be classified as "structural costs" - will never be subject to any modification. A classic example is rent, which can be adjusted at certain times and still remain part of the fixed cost group, since such adjustments will not be related to the oscillations in the production of the company.
In addition to rent, are also classified as fixed costs surveillance and security, telephone, cleaning, maintenance and related services.
What are variable costs
Variable costs, in turn, are directly linked to the company's production, undergoing changes from one period to another. The best example of this type of cost comes from raw materials: the more it is produced, the more material is used and therefore the greater the expense. Although the volume of production remains stable for some time, the cost of these materials will not be classified as fixed, simply because it is not tied to production.
Other examples of variable costs are direct labor, commissions and sales freights, and direct inputs.
Electric Energy, although usually classified as a variable cost, is part of a group of expenses that falls into the two categories: there is the variable part, which refers to the energy consumed in production, but there is also the fixed part, related to the administrative sectors of the company.
Viewing the difference between fixed and variable costs
For a better understanding of the difference between the two types of costs, let's use an example. In a table, we will list some types of fixed costs and variable costs.
From this first table, we will calculate the costs incurred during a quarter based on the production of this period, classifying them according to the type. The fixed costs in the example are represented by the sum of the telephone with security and the variables by the labor force and the sales commissions (which are logically multiplied by the units produced).
When we observe the values obtained, we can easily perceive the oscillation of the variable costs according to the quantity of units produced and how the fixed costs remain unchanged even with the changes in the numbers of the production.
If we want to obtain the unit cost of each product, as in the third frame, the logic is inverted: since the variable cost is obtained based on the production, it will remain constant, while the fixed unit cost will oscillate. We can see, observing the month of May, that the lower the production, the greater the fixed unit cost.
The importance of the difference between fixed and variable costs
Knowing how to differentiate fixed costs from variables is important because it offers subsidies for the definition of sales price based on oscillation of costs, as well as allowing the design of strategies to improve profitability. To implement these and other concepts, precise control of the company's cash flow is essential, with reliable and efficient tools.
With that in mind, LUZ.vc prepared the 3.0 Cash Flow Worksheet, which generates a series of graphs and tables from the launches made by the user that will provide a detailed analysis of the results and will serve as a basis for future decisions. Enjoy and know our spreadsheet.
Take advantage to test your knowledge with our exercise on the difference between fixed and variable expenses: