Fixed Cost
Candlefocus EditorDirect fixed costs are those incurred exclusively as a result of the production or sale of products or services. Examples of these costs include plant and machinery, patents and trademarks, as well as certain types of taxes and insurance. The cost of leasing production equipment is also a direct fixed cost, as these payments must be made regardless of activity levels.
Indirect fixed costs are incurred in the general running of a business, regardless of whether or not products or services are offered. Indirect fixed costs include rent, salaries, employee benefits, insurance, utilities and administrative expenses such as advertising.
Fixed costs are required for the operation of business, even when no revenue is being earned. They are recorded on the income statement as period costs, rather than as investments that generate future revenues.
Fixed costs can be a major contributor to profitability. For instance, if a business increases production and sales, the fixed cost associated with making the product may remain constant. This will result in a lower cost per unit, thereby increasing the profit margin. As production and sales decrease, however, the fixed cost associated with each unit increases and subsequent profit margins decrease.
Financial managers must consider the impact of fixed costs on the company’s financial standing. Sudden increases in fixed costs can pose a financial burden, especially if sales and profits are declining. If a business cannot reduce fixed costs quickly enough, they may be unable to weather any changes in market conditions.
In summary, fixed costs are a necessary component of running a business. These costs remain constant regardless of production or sales volume, and must be considered when gauging the additional costs required to produce a product or service. Fixed costs can greatly impact a company’s profitability and should be thoroughly evaluated before making any major business decisions. Understanding the impact of fixed costs on the income statement can help businesses accurately assess their current financial status, as well as plan for future growth.