When it comes to cutting costs, business owners employ a host of strategies. But, it is extremely important to know about fixed and variable costs if you want to stick to your budgets.
Fixed costs include expenses that stay constant for a period of time. These costs will remain the same irrespective of the level of output. Some of them include employee salaries, loan payments, and rent.
At the same time, variable costs change from time to time. Changes in business activity and output levels change them. Taxes, operational expenses, and direct labor are some examples of variable costs. All you need to do is have your variable cost formula set correctly, and you will be able to analyze these prices better.
You can use your online accounting software to break down these costs and have smooth financial management in place.
What are some examples of fixed and variable costs?
Fixed costs are determined beforehand and will not change for some time. If you want to gain an idea about these costs, you will need to analyze the expenses you would need to shell out if your business were to shut down temporarily.
These are insurance, overhead expenses, loan expenses, and rent. If you store all these parameters in cloud accounting, you will not need to enter them again and again.
Since these costs are fixed you can easily budget them. However, at the same time, they are not controllable as they are not proportional to the volume of operations and sales.
Talking about variable costs, they change and are impacted by business activities. These costs are likely to rise with improved business performance and the services your business generates. For instance:
- Direct labor costs
- Commissions paid to contractors
- Operational expenses
Since these change continuously, the amount you spend will vary from month to month. Moreover, such kinds of expenses are even harder to control and monitor. You will need to remember that these can cut your profit margin and even result in losses.
Fixed and variable costs examples
1. Fixed costs example
Let’s examine the charges involved when it comes to renting a building. First, you will need to negotiate with your landlord based on the square footage you need for your operations. Say, you get 5000 square feet at $40 (square foot) for ten years. So, the rent will come to $40,000 per month, whether you make a profit or loss.
But, you will need to note these costs will also not be fixed in the longer run. So, if you decide to take up more space or your owner needs to increase your rent, then you will need to plan your budget accordingly. But, you need not worry as you can leave the management part to your online accounting software.
2. Variable costs example
More the output, the more the variable cost. As per the variable cost formula, you must multiply the total output by variable cost per unit.
Operational expenses come under variable costs. As you grow your business, you will be needing more staff and amenities and other facilities to increase employee engagement.
They may increase/ decrease based on your business activities. But, the good part is that you can control them and also make room for profits.
Why do we need to differentiate between fixed and variable costs?
Online accounting software will help you track and understand how the costs change and what you can do to fix this.
The breakdown of your expenses can help you price your services better. Besides, it will also help you design your overall business strategy in a better manner. Some of these parameters include process costing, order costing, and activity-based costing.
1. Break-even analysis
Having the correct information on fixed and variable expenses will help you fix the right price for your services and make profits regularly.
Variable cost formula = fixed costs / (price – variable costs)
Not only does this help you gather insights, but it will also help you execute business expansion plans with ease.
It is ideal for those who are looking forward to investing stakes in a business. The formula will help them calculate the units and dollar volume they would need to make profits and understand if the numbers are worth making a decision.
2. Economies of scale
Identifying economies of costs will help you increase outputs and boost profitability. Both fixed costs and variable costs will help you understand your objectives better and develop a holistic business structure. It will also help you make rational decisions about your business expenses and make long-term decisions. All this and excellent financial management can be done with your cloud accounting software. Using one will provide a breakdown of costs and you will no longer need to spend your precious time and money doing that.
Having the right variable cost formula and online accounting software will help you budget better and take care of your financial needs. Also, developing an understanding of these costs will help you run your business better. If you would like to know about the best cloud accounting software, we are just a call away at +1-805-491-9393 or via mail at firstname.lastname@example.org.