Definition: A fixed cost is an expense that does not change as production volume increases or decreases within a relevant range. In other words, fixed costs are locked in place as long as operations stay within a certain size. Fixed costs are less controllable than variable costs because they aren’t based on volume or operations.
What Does Fixed Cost Mean?
Instead, management usually sets fixed costs at predetermined rates based on company necessities. Some examples of fixed costs include rent, insurance, and property taxes. All of these expenses are completely independent from production volume.
Example
For example, building rent is a fixed cost that management negotiates with the landlord based on how much square footage the business needs for its operations. If management decides to rent 10,000 square feet manufacturing plant at $50 a square foot, the rent will be $50,000 a month regardless of how many units the factory actually produces. The plant could produce 10 units or 50,000 units. The rent will always be same because it’s a fixed cost.
Management often uses fixed costs to base budgets and production schedules on. Since a business can’t get rid of its set costs, a certain amount of products need to be created and sold during each period to cover the expenses. Management typically looks at the break-even point where the revenues for a period equal the fixed and variable costs. This shows when the company will start producing a profit.
Keep in mind that these costs are only constant in a specific range of operations. Take our rent example. Rent will continue to be the same as long as the business occupies that space. After a few years, however, the business might grow out of that facility and require more manufacturing space. The rent would obviously go up if they decided to move to a bigger building. Thus, in a relevant range of operations the set costs stay the same.
