What is the difference between fixed costs and variable costs? Releasing what as the key to business financial management

In the world of business management, cost classification is one of the most essential skills. Costs are divided into two main categories: fixed costs and variable costs. Understanding the differences between these two will help managers make smarter decisions regarding product pricing, production planning, and profit evaluation.

Fixed Costs (Fixed Cost) - Costs that are inherent to the business

Fixed costs are expenses that a business must pay every month or year, regardless of how many units are produced or sold. These costs remain constant.

Fixed costs have three main characteristics

1. Independent of the level of production - For example, renting a conference room at 50,000 THB per month. Whether you produce 100 units or 10,000 units, the rent remains the same.

2. Must be paid even without any revenue - Even if the business hasn’t sold a single item, these fixed costs still incur expenses.

3. Long-term obligations - Usually contractual commitments such as lease agreements, employment contracts, or loan agreements.

Common examples of fixed costs in business

• Property rent: Warehouse, office, or factory rent
• Salaries of permanent staff: Monthly wages for management or accounting personnel
• Depreciation of machinery: Gradual reduction in value of machinery and equipment due to usage
• Insurance premiums: Property insurance, liability insurance, accident insurance
• Interest on loans: Payments to banks as per loan agreements
• Maintenance expenses: Annual repairs for buildings and critical equipment

Importance of managing fixed costs

Businesses with high fixed costs need a minimum sales level to cover these expenses first. Therefore, pricing strategies must consider the proportion of fixed costs.

Variable Costs (Variable Cost) - Costs that grow with the business

Variable costs are expenses that increase or decrease proportionally with the volume of production or sales. As production increases, variable costs rise; as production decreases, they fall.

Special characteristics of variable costs

1. Directly linked to production volume - The more you produce, the higher the variable costs.

2. Can be reduced if production decreases - Unlike fixed costs, which are unavoidable, variable costs can be controlled and lowered.

3. Flexible in planning - Businesses can adjust production according to market demand, and costs will automatically adapt.

Examples of variable costs in various businesses

• Raw materials and components: Fabric, metals, plastics, mechanical parts used in manufacturing
• Direct labor wages: Wages paid to workers directly involved in production (excluding administrative staff)
• Production energy costs: Electricity used by machinery, coolant in machines
• Packaging materials: Sealing boxes, foam inserts, stickers, packaging prints needed per unit
• Transportation costs: Payments to logistics companies for delivering products to distributors or customers
• Commissions: Payments to sales staff based on units sold

Why are variable costs interesting?

Variable costs are valuable tools for businesses because they enable accurate per-unit cost prediction and allow strategic adjustments in production according to market conditions.

How fixed costs differ from variable costs - A detailed comparison

Comparison table: Fixed Costs VS Variable Costs

Different impacts on business decision-making

When increasing production:

• Fixed costs stay the same = per-unit cost decreases = profit per unit increases
• Variable costs increase = per-unit cost remains normal

When decreasing production:

• Fixed costs still need to be paid = per-unit cost increases = potential profit reduction
• Variable costs decrease = immediate cost savings

Total cost analysis - A 3-tier system for decision-making

Successful businesses must balance fixed and variable costs.

Step 1: Calculate total costs

Total Cost = Fixed Costs + (Variable Cost per unit × Number of units produced)

Step 2: Set selling price

Selling Price = Cost per unit + (Desired profit margin %)

Example: If total cost per unit is 100 THB and desired margin is 40%, the selling price should be 140 THB.

Step 3: Evaluate break-even point

Break-even point = Fixed Costs ÷ (Selling price per unit - Variable cost per unit)

This indicates: How many units need to be sold to cover fixed and variable costs.

Application in investment decision-making

Decision: Use manpower or machinery

Suppose direct labor costs (variable costs) are very high. The company might consider investing in machinery, which will increase fixed costs (depreciation, maintenance) but reduce variable costs.

This decision is appropriate when: The business has a stable and high enough production volume to justify the increased fixed costs.

Decision: Entering new markets or not

Before entering a new market, calculate:

• How much will the new fixed costs be? (e.g., building a new factory)
• Can the business produce enough to cover these costs with increased machinery capacity?

Summary: Why are fixed and variable costs important?

Understanding the difference between fixed costs and variable costs is not just a theoretical financial skill but a practical management necessity.

• Fixed costs determine the business’s risk level — choosing high fixed costs, like expensive premises or many permanent employees, requires confidence in steady revenue.
• Variable costs provide flexibility — allowing production levels to adapt easily to market conditions.

Balancing both creates a solid foundation for the business, enabling survival during crises and sustainable growth. Smart cost management is the hallmark of successful managers.