Business Plan Center

How to identify fixed versus variable costs and lower expenses

Learn how you can save money by determining whether a business expense is a fixed cost versus variable cost.

Published: April 24, 2015

All of your business expenses are either fixed costs or variable costs. It's critical to understand the distinction between the two types of expenses to properly forecast your expenses and determine how you will cover them.

By analyzing your expenses and determining if they're fixed or variable, you can also identify opportunities to save money and ensure your pricing covers all costs of doing business.

How to decide: Fixed cost versus variable cost?

Your fixed costs don't vary depending on your production levels or sales volumes, and you have to pay them no matter how much money your business makes. Fixed expenses may include:

  • Rent

  • Insurance

  • Equipment leases

  • Salaried payroll

  • Telephone and internet expenses

  • Marketing and advertising expenses*

  • Vehicle expenses*

*Though these may increase when sales increase, they are still considered more fixed than variable.

Your variable expenses do change depending on your sales and production. Variable expenses are also called the cost of goods sold or the cost of sales. They may include:

  • Sales commissions

  • Hourly wages for field or service labor

  • Supplies and materials

  • Packaging and shipping

If sales increase, variable expenses will go up. If sales are slow, you may need to respond by reducing variable expenses.

The benefits of identifying your fixed versus variable costs

Knowing your fixed and variable costs can help you:  

  • Forecast your expenses accurately

  • Set optimal pricing for your products or services

  • Decide whether to expand your offerings or hold off for a future time

  • Gauge your profitability and create a plan to increase it

  • Calculate your business's monthly break-even point so that you know the point at which you'll profitable

Ideas for reducing your fixed and variable costs

Generally, your variable expenses will be easiest to reduce. Here are some ideas for lowering variable costs: 

  • Negotiate a bulk discount if your suppliers' rates are too high.

  • Review your memberships and subscriptions, and eliminate any unnecessary affiliations and fees.

  • Take advantage of free technology. Cloud computing, such as Google's word and data processing applications, can help you save on upfront and maintenance costs. Going paperless can also cut spending on office supplies.

  • Lower your utility bill by making sure your HVAC system is efficient and setting your lights to turn off automatically. Also, ask your electricity provider for a free assessment to help you identify opportunities to save money and energy. Several providers offer this service to small businesses.

While fixed expenses may be more difficult to cut, they aren't set in stone. Here are some ideas for reducing your fixed costs:

  • Lease your business equipment instead of buying it to reduce upfront costs.

  • Shop for more affordable insurance if your premiums seem too high.

  • Negotiate a longer lease term in exchange for reduced rent, or consider a co-working space where you can share the burden of overhead expenses.

  • Hire contractors or part-time employees to reduce labor expenses. Also, use commissions and bonuses as compensation to help you save on the cost of base salaries and benefits.

Finding ways to reduce fixed costs without compromising the quality of your products and services can boost your profitability. At a minimum, monitor these expenses to keep them from increasing faster than your revenue.

Consider raising prices, if necessary

Don't take a hatchet to expenses, or you could eliminate something vital. Instead, strategically reduce them without adversely affecting your business. If you can't reduce them enough, consider raising your prices. While it's important to manage your business expenses, your pricing needs to cover all legitimate costs and provide a healthy margin of profit.

Once you've made sense of your business's costs, use this knowledge to create cash flow forecasts.