Rent is a fixed expense you pay each month to use a commercial space for your business. The amount you pay will depend on the size and location of your office or retail store, as well as the length of your lease. These fluctuations may be influenced by the choices you make or by outside forces.
Variable expenses, on the other hand, can be more difficult to predict, since they can be influenced by so many different factors related to production and the market. As mentioned above, variable expenses do not remain constant when production levels change. On the other hand, fixed costs are costs that remain constant regardless of production levels (such as office rent). Understanding which costs are variable and which costs are fixed are important to business decision-making.
Because variable expenses are not steady, it might be hard to anticipate what you’ll pay for them each month. But examining your transaction history can help you learn your patterns and be aware of the general cost so you can adjust your budget if necessary. Even if you can’t control prices, you still have the power to set a limit on how much and how often you spend.
Items like electricity, however, will still be variable expenses because weather is difficult to anticipate. The length of a budget will also affect what are considered variable expenses. For example, a mortgage might have an adjustable rate of interest, and therefore might go up or down depending on the market interest rate. Usually the first few years of an adjustable rate mortgage, however, are at a fixed interest rate. So if you look at a budget for a year, the mortgage payment may not increase. As the production output of cakes increases, the bakery’s variable costs also increase.
It’s important not only that you have a budget but also that you make an effort to live your budget. This means that you go beyond simply planning out your budget and commit to the spending rules you’ve laid down for yourself. Living your budget may mean rethinking wants versus needs to avoid overspending. But the advantage of doing so is that you end up with a balanced budget without the risk of racking up high-interest debt. Our partners cannot pay us to guarantee favorable reviews of their products or services.
Another example of a variable expense is a retailer’s cost of goods sold. For instance, if a company purchases a product for $30 and is able to sell it for $50, the company’s cost of goods sold will be a constant rate of 60% ($30 / $50). Therefore, when the company has sales of $10,000 the cost of goods will be $6,000. Along the manufacturing process, there are specific items that are usually variable costs. For the examples of these variable costs below, consider the manufacturing and distribution processes for a major athletic apparel producer. Liliana Hall is an editor for CNET Money covering banking, credit cards and mortgages.
Because it is a bill you pay every month and remains roughly the same, a cell phone is a fixed expense. Still, you can work on bringing cell phone costs down to make sure this fixed expense fits in your budget. While most variable costs represent discretionary spending (such as restaurants, Starbucks, and golf), some variable costs represent necessities.
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Fixed expenses are a known entity, so they must be more exactly planned than variable expenses. After you’ve budgeted for fixed expenses, then you know the amount of money you have left over for the spending period. If you have plenty of money left, then you can allow for more liberal variable expense spending, and vice versa when fixed expenses take up more of your budget. Also, a savings account or emergency fund can provide cash you can dip into at times when your variable expenses are higher than expected.
The envelope system is one budgeting method that can help you balance your variable expenses. You start by assigning categories such as entertainment and transportation to individual envelopes. Then, allocate a certain amount of money to each one and spend only what you’ve designated.
Examples of variable costs are sales commissions, direct labor costs, cost of raw materials used in production, and utility costs. When interpreting the variable expense ratio, it’s essential to remember that many factors can affect it. For example, a change in accounting methods can impact the numerator (total variable expenses) without affecting the denominator (total sales). With proper planning, even very volatile expenses won’t have to derail your business plans. Your personal finances are not the only place you may encounter variable expenses. In a small business, a variable cost is an expense that changes according to production or, in some businesses, with changing weather conditions.
Since fixed expenses typically represent the biggest chunk of your budget, the money you save in this category can be quite substantial. Variable expenses can include essential expenses as well as discretionary spending. For instance, if you get sick, then a doctor visit may be a necessity that you need to cover.
In this way, a company may achieve economies of scale by increasing production and lowering costs. When it comes to managing your finances, understanding the difference between fixed and variable expenses is crucial. Fixed expenses, such as rent or mortgage payments, remain constant from month to month. However, variable expenses can fluctuate and impact your budget significantly. Most of your fixed expenses are inescapable — you can’t exactly cut your house or car payments. However, you may be able to eliminate a few unnecessary fixed expenses.
Saving money on housing, on the other hand, might require you to move or refinance your mortgage. One of the key elements to gaining financial stability is learning how to budget your variable expenses. Since they are unpredictable, variable expenses may come up when we least expect them and derail our spending plans for the month. The company faces the risk of loss if it produces less than 20,000 units. However, anything above this has limitless potential for yielding benefit for the company. Therefore, leverage rewards the company not choosing variable costs as long as the company can produce enough output.
Electricity varies each month, depending on the amount used in the household. If companies ramp up production to meet demand, their variable costs will increase as well. If these costs increase at a rate that exceeds the profits generated from new units produced, it may not make sense to expand. A cash book format company in such a case will need to evaluate why it cannot achieve economies of scale. In economies of scale, variable costs as a percentage of overall cost per unit decrease as the scale of production ramps up. Examples of fixed costs are rent, employee salaries, insurance, and office supplies.