Difference Between Fixed Cost and Variable Cost

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In finance and economics, one of the critical terms is the cost, which means the cost of production of goods or services. The production cost can now be classified into two major categories based on its nature: fixed cost and variable cost.

  • Fixed cost, as the name suggests, is fixed in nature during a certain period, and doesn’t depend on the activity level or output level. It can be considered a sunk costSunk CostSunk costs are all costs incurred by the firm in the past with no hope of recovery in the future and are not considered while making any decisions since these costs will not change regardless of the decision’s outcome.read more. One of the most popular examples is depreciation, which is charged on the fixed assets of a companyFixed Assets Of A CompanyFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples.read more. Now, the amount of depreciation remains constant (considering the straight-line methodStraight-line MethodStraight Line Depreciation Method is one of the most popular methods of depreciation where the asset uniformly depreciates over its useful life and the cost of the asset is evenly spread over its useful and functional life. read more) during the years of operation irrespective of production volume.On the other hand, the variable cost is directly proportional to the output level or production volume. A few of the popular examples are labor charges and material costs. Now, the production level solely derives from the total labor charge or raw material.

Fixed Cost vs. Variable Cost Infographics

Let’s see the top differences between fixed vs. variable cost.

Example

Interestingly, fixed cost is fixed at a gross level but can come down at a per-unit level with increased production. Let us consider a fixed asset of USD 1000 depreciated over ten years so that the annual depreciation chargeDepreciation ChargeDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. read more will be USD 100. Now, if the company produces ten units, the depreciation charge is USD 10 per unit, while if the company produces 100 units, then depreciation per unit comes down to USD 1 per unit.

While variable cost, on the other hand, is fixed at the per-unit level but increases linearly at a gross level with the increase in production. Let us consider a labor charge of USD 10 per unit, and if the company produces ten units, then the total labor charge is USD 100, while if the company produces 100 units, then the total labor charge is USD 1000.

  • Total cost of production for 10 units = USD 1000 + USD 100 = USD 1100Total cost of production for 100 units = USD 1000 + USD 1000 = USD 2000

Key Differences

  • Fixed cost remains constant at the gross level regardless of production volume. At the same time, the variable cost is that cost that changes at a gross level with the level of production.Fixed cost is time-related as it changes only after a certain period. Whereas the variable cost is volume related varies with the volume of production.Fixed cost is payable irrespective of whether there is any product or not. At the same time, the variable cost incurs when there is any production.At the unit level, variable costs remain the same, while fixed cost per unit varies. Fixed cost per unit reduces with the increase in volume production and vice versa.The fixed cost of production includes fixed production overhead, fixed administration overhead, and fixed selling & distribution overhead. Variable cost, on the other hand, includes raw material cost, labor costLabor CostCost of labor is the remuneration paid in the form of wages and salaries to the employees. The allowances are sub-divided broadly into two categories- direct labor involved in the manufacturing process and indirect labor pertaining to all other processes.read more, other direct expenses, variable production overhead, variable selling & distribution overhead.

Fixed Cost vs. Variable Cost Comparative Table

Final Thoughts

I hope the article helps you to decipher the two cost categories. As per the above explanations, both cost categories are very different and are essential in financial analysis. The higher volume of production results in better absorption of the fixed cost of production, which improves profitability, while variable cost per unit is instrumental in ascertaining the contribution margin at the product level. So, both the categories are used in unique ways to each other. As such, it is crucial to understand the various facets of the two to apply them successfully in a business scenario.

This article has been a guide to Fixed Cost vs. Variable Cost. Here we discuss the top differences with an example, infographics, and a comparative table. You may also have a look at the following articles –

  • 4 Examples of Sunk CostFixed Cost ExamplesAverage Variable Cost FormulaEconomies of Scale vs Economies of Scope