Fixed vs. Variable Expenses

Expenses might be fixed or variable – but often, they’re a bit of both

One of the first distinctions many finance folks learn is between fixed and variable expenses. It’s an important concept for financial analysis and planning and it’s used by CFOs as well as the youngest finance students. It’s equally crucial, though, not to let this valuable working distinction trap you in a binary frame of thought that limits your ability to predict financial realities effectively. 

In this article, we’ll explore fixed versus variable expenses examples, the mixed nature of real costs in real life businesses, and what to remember to make the most of this useful tool without being constrained by it. 

Fixed and Variable Expenses Examples

Fixed expenses versus variable expenses are exactly what they sound as if they should be, but it’s not always as clear cut as you might think, which is why examples are important in really understanding the difference. 

A fixed expense is essentially a cost that is reliably the same from month to month, i.e. the amount on your budget stays fixed. Examples might be:

• Rent
• Property taxes
• Loans / interest that needs to be paid
• Leased equipment, machinery or software

A variable expense, by contrast, is a cost that may well vary from month to month, i.e. the amount on your budget may vary. Examples might be:

• Sales commissions
• Utilities (electricity, water, gas etc.)
• Raw materials
• Shipping/packaging costs

Why Businesses Care About Fixed vs. Variable Expenses (Examples)

Whether you’re planning a budget, looking to cut expenses, aiming for accurate forecasts, or a range of other elements in financial analysis and planning, you need to be able to differentiate between fixed costs and variable costs. 

Fixed expenses are numbers you can plan around, that represent predictable stepping stones in your budgeting path. Variable expenses must be tied to relevant production predictions and numbers, and different scenario plans must reflect this interdependence. 

When companies are thinking about change in a business, the fixed versus variable distinction is also important. When a company is young and growing, it may make sense to avoid fixed expenses as much as possible, until the business model and product-market fit are proven. This enables greater flexibility and agility. 

On the other hand, companies that have tried-and-tested popular lines may want to examine how shifting to an emphasis on fixed costs can reduce their overall costs as they scale.

For example, there’s the gap between outsourcing and in-house. If you look at a large, established business, there are many things that may make sense to run in-house, from manufacturing to recruitment to storage and shipping. At scale, it can work out much cheaper, and increases the amount of control and predictability that is possible. 

A young business would want to avoid all these high fixed costs, however, and outsource all or many of these until they find their rhythm. 

Avoid Confusion Around Fixed vs. Variable Expenses (Examples)

Fixed vs. variable expenses seems like a clear distinction, but in practice it can be more complex than it first appears. 

Even before getting into the messy reality of semi-fixed and semi-variable expenses, it’s important to note that you need to be clear about the definitions being used within your own organization, make sure you’re using them consistently, and that all the information you need is centralized in one place. Data silos are the enemy here (this is why platforms like Firmbase are becoming popular with many finance teams).

For example, some models refer to labor/salaries as a fixed cost, while others treat it as a variable cost. What’s really going on here is usually that they’re talking about different things. 

Direct labor is a variable expense, in that it’s tied to production. If your factory makes 1,000 bicycles one month, you will need more labor than if you’re making 10 bicycles a month. Some businesses are very sensitive to this kind of variation seasonally. Salaries of salaried employees, on the other hand, represent fixed expenses. They don’t change depending on production. 

In the same way, how your company treats things like raw materials, shipping or even rent may depend on the industry or business model. If your industry typically locks in prices for raw materials over a year in advance, or if you’re running a type of business that controls much of its own shipping, you may not consider these variable costs. Equally, if you’re working in a pop-up type model, you may not consider rent to be fixed. 

What matters is not that you force your department to use “industry standard” terms and definitions, but rather that you are clear about what you mean when you use terms, are clear what other departments mean, and use the models that best fit your business reality. This isn’t about accounting classification. It’s about the role costs play in your actual business.

Semi-Fixed or Semi-Variable Expenses (Examples)

The fixed versus variable expenses examples seemed clear at the start of this article. We’ve just seen that not all expenses are as clear cut as they might appear, though. Now we’ll go a step further: Many expenses are neither fixed nor variable. They’re mixed. 

Rent is a fixed cost. Unless it isn’t. 

• If your business is growing fast and needs more warehouse, manufacturing or retail space, you may be entering complex territory calculating how the company’s rent expenses increase over the course of a year. 
• If your business is shrinking, you may need to end leases early, or renegotiate rental terms. 
• If you’re in areas where space costs are dynamic (either rising or falling) then the rent of a single space may well change, sometimes considerably, over the course of a year, 3 year or 5 year period. 
• If you’re in a shared workspace, you’re vulnerable to any changes mandated by the company that runs the space.
  

These aren’t changes that are variable; they don’t shift from month to month, and the changes are not necessarily tied to production. But they aren’t quite fixed either. They’re a mixed expense.

SaaS companies that rely on many cloud-based services, especially for data storage and retention, etc. have a similar dynamic. 

• If your business is young, you may be able to use freemium or basic packages that are fixed costs. 
• Or alternatively, you may be able to use a variable expenses model, in which everything is usage-based. 
• As it grows, however, you’ll likely get into far more complex calculations with tiered pricing, and a mix of fixed fees and usage-based prices. 
• You may even get to custom pricing, which can be broken down by product, geography and usage. 

Many expenses can be thought about in similar ways. Salaries that involve commission have both a fixed and a variable aspect, for instance, and that can become increasingly important to acknowledge if you’re exploring creative ways of structuring compensation. In fact it’s hard to think of an expense that might not be mixed in one way or another in certain circumstances.

Rather than thinking of expenses as binary – fixed versus variable – it can be more helpful to think about them as existing on a spectrum. Over time, a particular expense for your specific business may be more fixed, or more variable.  

Track Expenses to Avoid Surprises

The mental model of fixed, variable and mixed expenses is valuable for helping finance professionals build a framework to understand the costs their business has and how to work with these in predictions, growth plans and expense cutting exercises. 

The distinctions aren’t useful, though, unless you’re applying them consistently and reliably to your company’s business data. This isn’t about a technical accounting or financial classification, this is about how expenses actually behave for your business at this time, and this stage of growth. 

Use the definitions of fixed, variable and mixed expenses, in conjunction with an in-depth, segmented, real-time understanding of your actual costs, to ensure your business has the clarity and financial depth it needs to make the data-driven decisions that drive stability and success. 

Learn how Firmbase helps FP&A teams create budgets, run forecasts & analyze important financial insights.