Fixed Vs Variable Expenses: Whats The Difference?

Our editorial team does not receive direct compensation from advertisers. For instance, if you analyze your grocery spending and find that you spent $640 in January, $715 in February and $590 in March, you could add these three numbers together and divide by three. You’d get $648.33, and could safely assume your average grocery bill might be around $650 per month.

  • For this reason, variable costs are a required item for companies trying to determine their break-even point.
  • Restaurant meals, charitable giving and travel are all examples of variable expenses that are generally completely optional.
  • Writers and editors and produce editorial content with the objective to provide accurate and unbiased information.
  • Trimming variable costs, on the other hand, requires actively making multiple decisions every day about whether or not to buy certain items or participate in specific events.

In either situation, the variable cost is the charge for the raw materials (either $0.50 per pound or $0.48 per pound). Once a year, for example, you could ask employees to provide feedback on certain costs. You
may identify software you’re not using, for example, or alternatives that are more cost effective. You may be able to incentivize employees to help you find these opportunities to cut costs.

There is another type of expense category that’s referred to as “discretionary expenses.” These are “optional” purchases, such as entertainment and restaurants. Many or all of the products featured here are from our partners who compensate us. This influences which products we write about and where and how the product appears on a page. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. In effect, a company with low operating leverage can be at an advantage during economic downturns or periods of underperformance.

What Is a Variable Expense?

A variable expense is a cost that alters in conjunction with some type of activity. For example, the direct materials expense increases as sales increase. Other variable expenses are commissions, billable labor, piece rate labor, and credit card fees. Many other expenses, such as rent expense, are fixed within a certain activity range. The average variable cost, or “variable cost per unit,” equals the total variable costs incurred by a company divided by the total output (i.e. the number of units produced).

  • The credit card processor charges the business a fee of 3% of each amount charged.
  • Other examples include clothing, vacation costs, holiday gifts and eating out.
  • You might normally treat yourself to one muffin each week, spending $4 on average per month, but some months you might indulge more and spend $10 or $15.
  • You start by assigning categories such as entertainment and transportation to individual envelopes.
  • If you opt to set aside the same amount of money for short-term savings and another chunk for retirement monthly, you’ll put yourself in a financially secure position.
  • It’s important to understand how much of your expenses are fixed and how much are variable so you can budget your money properly.

This assumes, of course, that you’re able to pay the balance off in full before the promotional rate ends. You could also consider refinancing student loans or consolidating debts with a low-interest rate personal loan to save money. For example, saving money on renter’s insurance, homeowner’s insurance or car insurance may be as simple as shopping around for a better deal with a different insurer. Saving money on housing, on the other hand, might require you to move or refinance your mortgage. Assume that a website business sells a product and requires the customer to pay with a credit card.

Break Them Down Into Monthly Costs

Fixed costs remain the same regardless of whether goods or services are produced or not. As such, a company’s fixed costs don’t vary with the volume of production and are indirect, meaning they generally don’t apply to the production process—unlike variable costs. The most common examples of fixed costs include lease and rent payments, property tax, certain salaries, insurance, depreciation, and interest payments. Variable costs are any expenses that change based on how much a company produces and sells. This means that variable costs increase as production rises and decrease as production falls. Some of the most common types of variable costs include labor, utility expenses, commissions, and raw materials.

That’s It! No More Ugly Budget Surprises

Watch this short video to quickly understand the main concepts covered in this guide, including what variable costs are, the common types of variable costs, the formula, and break-even analysis. ​Let’s consider a hypothetical example in the restaurant industry to demonstrate how to calculate and analyze the variable expense ratio. The Variable Expense Ratio enables analysis of the profitability and cost efficiency of the business. This allows the business to set the pricing of products and provide goals & profitability projections. Liliana Hall is an editor for CNET Money covering banking, credit cards and mortgages. Previously, she wrote about personal credit for Bankrate and

Some positions may be salaried; whether output is 100,000 units or 0 units, certain employees will receive the same amount of compensation. For others that are tied to an hourly job, putting in direct labor hours results in a higher paycheck. In conclusion, we can check our work using the alternative formula with the contribution margin, which yields a variable expense ratio of 40.0%. Based on the insights derived from the metric, a company’s management team can set pricing rates and production scheduling appropriately to maximize its profit margins. Another example would be an SaaS product that charges a
base amount on a monthly basis but charges more when the number of users or usage exceeds
a specific amount. Examples here could include business appointment software used by your
salespeople, or website hosting or email hosting services.

Fixed Vs. Variable Expenses: What’s The Difference?

It’s important to track your spending so you know where your money goes and can plan accordingly. Variable expenses aren’t always predictable, but they often allow more flexibility in your budget. We believe everyone should be able to make financial decisions with confidence. Suppose that a consulting company charged 1,000 hours of services to its clientele. 6 The portion of your credit line that can be paid to your cards will be reduced by the amount of the annual fee. Variable expenses can be discretionary — but they can also be necessary.

You’re our first priority.Every time.

These kinds of payments can be the same each month for the entire period of time in which you’re obligated to pay them. Aside from being roughly the same amount each month, fixed expenses may also be paid on or around the same date each month. Again, the advantage here is that planning out your budget may be easier to do with recurring bill payments. If you budget by paycheck or schedule automatic bill payments, having bills due at roughly the same time can help with avoiding late payments and the fees that go along with them.

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. Trimming variable expenses is more difficult than cutting discretionary spending.

Leave a Reply