Fixed and Variable Costs

The split shows where the risk sits. A business heavy in fixed costs must reach a certain volume just to survive, but beyond that point extra sales are very profitable because the fixed base is already paid for. A business heavy in variable costs is safer in a downturn because costs fall with revenue, but every sale still carries its own cost, so margins stay thinner.

It also gives the break-even point: fixed costs divided by what each sale contributes after variable costs. With €12,000 of fixed costs a month, a price of €100 and variable costs of €30 per sale, each sale contributes €70. Break-even is about 172 sales a month.

• Tag every expense as fixed, variable or step in the books from the start.
• Work out contribution margin per sale, and recalculate break-even whenever prices or volumes change.
• Keep costs variable while demand is unproven, and commit to fixed costs once volume is predictable.
• Watch per-sale costs that creep up, since they cost money on every unit sold.
• Review the split when a pricing model or way of delivering changes how a cost behaves.

Fixed costs are due whether the month brings one customer or fifty: rent, salaries, insurance, most software subscriptions. Variable costs move with activity: card fees, packaging, shipping, a freelancer paid per project, support tools billed per ticket. Some costs sit between the two. A step cost stays flat until volume passes a threshold, such as hiring another support agent. A software plan priced per seat is fixed in the short run and variable over a year.

• Treating salaries as variable because people can be let go. Notice periods and redundancy make them fixed in practice.
• Ignoring step costs, then being surprised when growth forces a jump.
• Comparing months without separating the two, so a bad month looks like a pricing problem when it is a volume problem.