What is the difference between fixed costs and variable costs?

Fixed costs and variable costs are fundamental concepts in cost accounting and financial management, important for understanding how costs behave in relation to production levels.

The definition of fixed costs is that they remain constant regardless of the production volume. This means that, whether a company produces a large number of goods or none at all, these costs—such as rent, salaries, and insurance—will not change. This characteristic makes fixed costs predictable and essential for long-term financial planning.

On the other hand, variable costs are directly tied to the level of production. As production increases, variable costs rise proportionately, and when production decreases, these costs fall. Common examples of variable costs include raw materials and direct labor associated with manufacturing.

This understanding of how fixed and variable costs interact is crucial for businesses as they make decisions regarding pricing, budgeting, and financial forecasting. Recognizing that fixed costs do not fluctuate with production levels while variable costs do is key to managing a company’s financial health.