What is the difference between fixed costs and variable costs?

Fixed costs are expenses that do not change with the level of production or sales within a certain range. This means that regardless of how much a company produces—whether it is producing zero units or thousands of units—fixed costs remain the same. Examples of fixed costs include rent, salaries of permanent staff, and insurance. These costs are incurred even when the production is idle.

Understanding fixed costs is essential for businesses as they allow for budgeting and forecasting in a predictable manner. This stability enables organizations to plan for long-term financial strategies without the anxiety of fluctuating expenses tied to production levels.

The distinction from variable costs is important, as variable costs fluctuate in direct correlation with production volume, increasing as production increases and decreasing when production goes down. This is what helps companies analyze their cost structures and make decisions about scaling production, pricing strategies, and profitability.