Dream Cheeky will help you know What Does Fixed Cost Mean 2022: Top Full Guide
Fixed Cost Examples
A fixed cost is a cost that is independent of how many products or services a business provides. So whether a company produces one hamburger or 100, the cost is the same.
Some examples of fixed costs include:
1. New Building/Factory
When a business invests $10 million in a new factory, it counts as a fixed cost. It is a one-off cost that does not vary based on output. In accounting terms, it is the depreciation that is considered a fixed cost. For instance, if the factory was to last 10 years, there would be an annual depreciation of $1 million per year. So rather than having a one-off fixed cost of $10 million, the costs are amortized so the cost is split out through the 10 years.
Effectively, the factory has a value as an asset during the 10 years – until it is no longer productive. As it could potentially be sold on and produce output for x number of years, it still has a value. So although it may cost $10 million to buy, it is still seen as an asset in accounting terms. In other words, $10 million isn’t spent but rather invested in an asset – shares are a similar example. It is only once the value of the asset starts to decrease by which we can consider as a fixed cost. Think of the depreciation of a car for example.
Rent is an annual or monthly charge which is a fixed cost. A business has to pay this regardless of how many customers it serves. For example, a barber will have to pay rent whether they cut one persons hair or twenty people. This may increase in line with inflation, but is fixed for a set period of time.
3. Contracted Salaries
Contracted salaries relate to the annual salary of a business’s employees. Once contracted, this counts as a monthly and annual fixed cost. The employee may be busy and produce 10 times the normal output, or, they may be extremely unproductive and produce half. No matter how productive the employee is, the cost remains fixed. By contrast over-time hours, or incentive based pay counts as a variable cost, as this varies month on month and increases with output.
Businesses must pay for property and other forms of insurance each year. This is a fixed cost because it doesn’t matter how many products or services they provide, they still have to pay insurance. It could be argued that this is variable, as insurance costs can increase as the firm gets bigger. For example, the cost to insure a large multi-national is much higher than the local mom and pop store.
However, it is a fixed cost because insurance is charged based on risk rather than output. Insurance costs increase in line with risk rather than in line with output. Furthermore, insurance prices do not react to incremental increases in production as a variable cost does. In other words, production may increase by 10, but it has no impact on insurance prices as a fixed cost.
When taking out a loan, there are a number of fixed-rate options available. If a business takes up such an option, this can count as a fixed cost. A charge on the loan is due every month or year, independent of how much goods the business produces and sells.
By itself, advertising does nothing to increase output. It is not like an additional employee, or the cost to keep the lights and machines on for an extra hour. It is a fixed cost. This is because businesses set an advertising budget, which tends to only vary quarter on quarter. On top of that, advertising costs are still payable whether the business serves one customer or one million!