A Guide To Variable Costs, Fixed Costs, And Total Costs

What Are Fixed Costs, Variable Costs, And Total Costs?

Understanding the differences between fixed costs, variable costs, and total costs is essential for small business owners seeking to optimize profitability and make informed decisions. Fixed costs are those expenses that remain unchanged regardless of production volume, while variable costs fluctuate with your business activity. Total costs represent the sum of both, directly impacting your bottom line and forming the foundation of effective financial planning and management. Working with a fractional CFO can help small businesses interpret these costs more strategically, offering expert guidance without the commitment of a full-time hire.

Definition Of Fixed Costs

Fixed costs are recurring expenses that do not vary with the level of goods or services produced by your business. Examples include rent, salaried employees, insurance premiums, and lease payments for equipment. Since these costs remain constant even as sales fluctuate, they play a crucial role in long-term budgeting and forecasting. For instance, if you rent an office space for $2,000 per month, that expense does not change even if you double your sales or produce fewer products in a given month.

Definition Of Variable Costs

Unlike fixed costs, variable costs increase or decrease based on your company’s output. Common variable costs include raw materials, sales commissions, production labor, shipping costs, and utility expenses directly tied to production. These costs offer more flexibility for business owners to manage during slow periods or ramp up during busy seasons. By closely monitoring and projecting these, you can better align your expenses with revenue streams.

Explanation Of Total Costs

Your total costs are the combined sum of fixed and variable costs over a specific period. The total cost formula is a fundamental concept in business finance:

• Total Costs = Fixed Costs + Variable Costs

This figure helps you determine pricing strategies, calculate gross profits, and assess overall financial performance. Without clarity on your total costs, it can be challenging to set the right sales targets or understand your true profitability.

Importance In Business Decision-Making

The distinction between fixed and variable costs is not just theoretical—it’s vital for daily and strategic decision-making. For example, understanding your cost structure can inform whether you should scale production, adjust pricing, or seek cost-saving opportunities. Businesses with high fixed costs must focus on maximizing output to cover those constant expenses, while those with predominantly variable costs may be more adaptable to market changes. Financial institutions or investors also analyze your cost structure to assess risk and scalability.

Overview Of How These Costs Impact Financial Planning

Effective financial planning requires a precise understanding of both fixed cost examples (like insurance or lease payments) and variable costs (for instance, shipping based on order volume). This distinction is critical when preparing budgets, stress-testing business models, or setting break-even targets. By leveraging tools and guidance from an experienced partner like Milestone, small business owners can build robust budgets, reduce financial uncertainty, and confidently plan for growth. Our comprehensive accounting services ensure you always know where you stand—and where you can go next.

What Are 5 Examples Of Variable Costs?

Variable costs are expenses that fluctuate directly with the level of production or sales activity. Unlike fixed costs—which remain unchanged regardless of how much you produce or sell—variable costs increase as you produce more and decrease as you produce less. Understanding which expenses qualify as variable costs can help small business owners forecast, budget, and determine pricing strategies effectively. Here are five common examples of variable costs that are relevant across many businesses:

Direct Materials

Direct materials are the raw components required to manufacture your products. For example, if you own a bakery, flour, sugar, and eggs are direct materials because you purchase more of them as you bake more goods. Monitoring these variable cost examples closely allows you to gauge how your production volume influences your total expenses.

Sales Commissions

Sales commissions represent payments made to sales staff based on units sold or revenue generated. The more sales your team closes, the higher your total sales commission expense will be. This makes commissions a classic variable cost, ideal for incentivizing performance while aligning expenses with revenue growth.

Shipping And Delivery Expenses

Shipping and delivery costs vary depending on the volume of goods shipped. If your business experiences increased orders, your variable costs related to shipping will rise accordingly. Factoring in these variable cost examples is especially important for e-commerce and distribution-focused businesses.

Utilities Dependent On Production

Some utility costs, such as electricity or natural gas, change based on your operational activity. For instance, running more machinery during high production periods will increase your utility usage and, consequently, your variable costs. Understanding how utilities fluctuate helps you budget more accurately during peak and off-peak times.

Credit Card Transaction Fees

Whenever customers pay by card, your business incurs credit card processing fees. The total monthly fee amount increases as your sales volume goes up. This is a significant and often overlooked variable cost, especially in retail and service-based sectors.

Are There Other Industry-Specific Variable Costs?

While the above are common examples, many industries have unique variable costs. For example, in the hospitality industry, laundry services and guest amenities increase with occupancy rates. In service-based businesses, subcontractor fees may fluctuate with the number of projects. Identifying all your business-specific variable costs ensures a comprehensive understanding of your variable cost formula and enables better financial decision-making.

What Is The Difference Between TFC And TVC?

The primary distinction between TFC (Total Fixed Cost) and TVC (Total Variable Cost) lies in how each cost type responds to changes in business activity. TFC represents costs that remain stable regardless of production or sales volume, while TVC fluctuates directly with the level of output or sales. Understanding this difference is crucial for small business owners and entrepreneurs when budgeting, forecasting, and making informed financial decisions.

Definition Of TFC (Total Fixed Cost)

Total fixed cost (TFC) refers to business expenses that do not change with the amount of goods or services produced. These include recurring payments like rent, salaries for permanent staff, insurance premiums, and equipment leases. Whether you produce a hundred units or none, these costs remain constant over a period. The total fixed cost formula is simply the sum of all fixed expenses within a given period.

Definition Of TVC (Total Variable Cost)

Total variable cost (TVC), on the other hand, includes expenses that increase or decrease in direct proportion to business activity. Examples are raw materials, direct labor tied to production, and utility bills that scale with manufacturing output. The formula for variable cost is: 

• TVC = Variable Cost per Unit × Number of Units Produced 

As output rises, so does the TVC, and vice versa.

Impact On Total Cost Calculation

Your total cost structure is determined by the combination of fixed and variable costs. The total cost formula is: 

• Total Cost (TC) = TFC + TVC

This distinction enables owners to forecast how different business scenarios—such as ramping up production or scaling back—will affect overall expenses.

Behavior Of Each Cost Type As Output Changes

TFC remains unchanged regardless of output, which means that as you produce more units, the fixed cost per unit decreases (a phenomenon known as economies of scale). In contrast, TVC rises with each additional unit, maintaining a consistent variable cost per unit but increasing the aggregate variable cost as output grows. This sensitivity makes TVC a focal point in day-to-day operational decisions.

Examples Illustrating The Differences

Consider a printing business that pays $2,000 per month in lease (TFC) and incurs $1 in paper and ink per brochure printed (TVC). Whether they produce zero or 5,000 brochures, lease costs do not change. However, if they print 1,000 brochures, their TVC is $1,000. At 5,000 brochures, the TVC rises to $5,000. Recognizing these differences empowers business owners to manage margins, set pricing, and determine breakeven points with greater confidence.

Milestone’s financial experts can help you break down your fixed and variable costs, using tailored analyses to make data-driven decisions, optimize operational efficiency, and proactively plan for growth—all while ensuring your budget aligns perfectly with your changing needs.

How To Calculate Variable Cost From Total Cost And Fixed Cost?

Calculating variable costs is a straightforward but essential process for small business owners and entrepreneurs aiming to gain precise control over their budget and pricing strategies. The method involves subtracting your fixed costs from your total costs, resulting in a clear figure reflecting only those expenses that change with your business’s output or sales levels. Mastery of this calculation empowers you to make smarter business decisions, optimize profit margins, and forecast future financial performance more accurately.

What Is The Formula For Calculating Variable Cost?

The simplest and most commonly used variable cost calculation formula is:

• Variable Cost = Total Cost – Fixed Cost

This straightforward equation enables business owners to quickly separate the costs that fluctuate (like materials or commissions) from those that remain constant regardless of output. Understanding this difference can help you pinpoint areas for cost savings and understand your business’s cost structure.

Step-By-Step: How To Calculate Variable Cost

Let’s break down the calculation process into actionable steps:

• Step 1: Identify your total costs for a specified period (monthly, quarterly, annually). This includes every expenditure related to running your business.
• Step 2: Determine your total fixed costs for the same period. These are costs like rent, salaries, insurance, and other expenses that do not vary with production levels.
• Step 3: Subtract your total fixed costs from your total costs. The result is your total variable cost.

Sample Calculation

Suppose your small business incurs total costs of $120,000 per year, including $50,000 in fixed costs (rent, insurance, salaried staff). Applying the formula:

• Variable Cost = $120,000 (Total Cost) – $50,000 (Fixed Cost) = $70,000

That $70,000 includes all expenses that move with your business activity, such as materials, commissions, and utilities tied to production.

Applying The Variable Cost Formula To Your Budget

Accurate variable cost calculation is critical for developing robust budgets and financial forecasts. By knowing which costs rise with sales or production, you can better plan for busy seasons, price your products or services profitably, and avoid cash flow surprises. Additionally, separating variable from fixed costs allows for more effective break-even analyses and helps pinpoint which costs can be trimmed or negotiated as your output shifts.

Common Pitfalls To Avoid

Many small businesses run into trouble by misclassifying costs or by not updating their data regularly. Variable costs can shift as your business grows, suppliers alter their prices, or as you expand into new markets. Always review and update your cost breakdowns regularly to ensure your calculations reflect current realities. Be cautious not to include semi-variable expenses (like utility bills with a base fee) entirely as variable—only the portion that changes with usage should be counted as such.

With a clear understanding of your variable costs, you gain a powerful tool for controlling expenses and aligning your business for profitability. If you find the calculations complex or need support to integrate these metrics into your long-term planning, Milestone is here to help. Our expert team can break down your cost structure, streamline your accounting, and customize budget strategies that unlock new levels of efficiency and growth for your business. Partner with Milestone to make every dollar count and lay the groundwork for lasting success.