Fixed Costs Definition – Meaning, Examples and Importance

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Fixed Costs Definition, Meaning and Examples

Fixed Costs Definition – “Costs that remain constant in the short run regardless of sales volume; they include administrative salaries, interest, rent and insurance”.

In simple words, these are those costs, that remains same no matter what the output or sales is. These costs can never be zero. Whether production takes place or not, there will be fixed cost. It is one of the component of total costs just like variable costs.

These are the expenses that business has to bear irrespective of the business activity. It is the most basic cost that can never be avoided such as rent, property taxes, insurance etc. In addition to this, these costs play an important role in deciding the profitability of the business.

Fixed Costs Example

Suppose there is a XYZ Pvt. Ltd that manufactures notebooks. Assume it costs Rs. 4,o0,000 to produce 20,000 notebooks, Rs 20 per notebook. This 4,00,000 includes Rs. 1,50,000 of rent, administrative expenses, insurance and marketing expenses. Next year, company decides to produce 40,000 notebooks. Now the cost may rise to 6,00,000 as the fixed cost remains constant. Now cost of 1 notebook becomes 15.

Importance of Fixed Costs

Fixed costs definition is incomplete without its definition. It plays a very important role in projecting the profits of the company. Comparatively, large amount of variable costs predicts more accurately per – unit profit margins. This indicates that, if a firm has large fixed costs, the profit margins falls when sales falls. Similarly, if sales increases the profit margin also increases as fixed costs remain constant.

However, there are some industries which involves very high fixed costs. This discourages new players to enter in that industry. Business which are more capital – intensive requires huge investment in fixed costs. For examples – Aviation, automobile companies requires huge investments, which increases the fixed costs. On the other hand businesses like website designing, insurance, etc requires very less fixed costs. Here labor cost is more that is variable cost is quite high. So, when comparing fixed costs, one should compare costs within the same industry.

Related Financial Terms of Fixed Costs

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