Fixed vs variable costs
Definition
Fixed costs stay the same in total regardless of how much a business produces or sells within a relevant range, such as rent, insurance and salaried wages. Variable costs change in total in direct proportion to activity, such as raw materials, packaging and sales commissions. Some costs, called mixed or semi-variable costs, contain both elements.
Formula
Total cost = Fixed costs + (Variable cost per unit × Number of units)
Why it matters
Knowing which costs are fixed and which are variable lets you predict profit at different sales levels, set prices, and calculate your break-even point. It also shows how much risk you carry if sales fall, since fixed costs must be paid either way.
Example
A T-shirt printer pays $2,000 per month in rent (fixed) and spends $6 per shirt on blanks and ink (variable). Producing 500 shirts costs $2,000 + (500 × $6) = $5,000 in total, while producing 1,000 shirts costs $2,000 + (1,000 × $6) = $8,000.
Common questions
Is payroll a fixed or variable cost?
It depends. Salaries that do not change with output are fixed, while hourly wages tied to production volume and commissions tied to sales are variable.
Why does fixed cost per unit fall as volume rises?
Because the same total fixed cost is spread over more units. For example, $2,000 of rent is $4 per unit at 500 units but only $2 per unit at 1,000 units.
Related Terms in Purchasing & Inventory
Perpetual inventory system
A perpetual inventory system is a method of tracking inventory that updates quantities and costs continuously, recording each purchase and sale as it happens. Cost of goods sold is recorded at the time of each sale, so inventory balances are always current in the books.
Periodic inventory system
A periodic inventory system is a method of tracking inventory where purchases are recorded in a purchases account and inventory is updated only at the end of a period based on a physical count. Cost of goods sold is calculated as a single figure at period end.
Inventory Valuation
Determining the monetary value of stock on hand, which sets both the balance-sheet asset and cost of goods sold. The method chosen, FIFO, LIFO or weighted average, changes reported profit when input prices move, so it must be applied consistently.
LIFO (Last In, First Out)
An inventory costing method that charges the most recently purchased stock to cost of sales first. In a rising-price environment it reports higher cost of sales and lower profit than FIFO. Permitted under US GAAP but prohibited under IFRS.
Stop memorising terms — let HelloBooks do the work
AI-assisted bookkeeping that handles invoicing, GST, reconciliations, and reports automatically. Free to start.