Managing variable costs and fixed costs to improve business efficiency

In modern business operations, managers must understand the structure of costs, including both variable and fixed costs, because this is the key to making smart decisions. Whether setting product prices, planning production, or controlling expenses effectively, this knowledge is essential. This article will delve into how variable and fixed costs impact the financial health of a business.

Fixed Costs That Do Not Change with Business Seasons

Fixed costs are expenses that the organization must pay regularly, regardless of whether the business has low or high activity levels. This characteristic distinguishes them from other types of costs.

Common examples of fixed costs include rent for factories or offices, salaries of executives and permanent staff, business insurance, depreciation of machinery, loan interest, and membership fees for platforms the business regularly uses. All these costs occur whether the company produces or sells large or small quantities.

Variable Costs That Change with Production Levels

Variable costs are entirely opposite to fixed costs. They increase or decrease based on the volume of production or sales. As a company produces more goods, variable costs rise proportionally; when production decreases, these costs fall.

Expenses in this category include raw materials and components used in manufacturing, direct labor wages for workers involved in production, energy costs, water, packaging, transportation, delivery fees, and commissions based on sales generated by the sales team. Variable costs are highly flexible and can be decided upon in each period.

Key Differences Between the Two Types of Costs

Distinguishing between fixed and variable costs is a fundamental aspect of cost management. Fixed costs remain constant regardless of production volume, while variable costs change directly with it.

For each unit produced, the fixed cost per unit decreases because it is spread over a larger quantity. For example, if rent is 100,000 THB per month, producing 100 units results in a fixed cost per unit of 1,000 THB. Producing 1,000 units reduces the fixed cost per unit to only 100 THB.

Variable costs per unit tend to stay constant because each unit requires the same amount of raw materials, labor, energy, and packaging. This means that increasing production raises total costs, but the cost per unit may decrease due to efficiency gains.

Cost Analysis for Smarter Decision-Making

Understanding and analyzing both types of costs help managers make better decisions in various areas:

Pricing: Companies need to ensure that selling prices cover both fixed and variable costs and generate sufficient profit. If prices are too low, costs may not be covered.

Production Planning: Businesses can estimate the optimal production volume to break even and identify levels that maximize profit. The break-even point is calculated by dividing fixed costs by the contribution margin per unit (selling price minus variable cost per unit).

Investment Decisions: Managers may consider investing in new machinery to reduce variable labor costs, even if it increases fixed costs. If the total costs decrease as a result, the investment is likely beneficial.

Cost Control: Companies should identify high-cost areas and seek improvements. Fixed costs may need to be accepted, but variable costs can be reduced through better raw material procurement or process efficiencies.

Application in Different Business Situations

Cost structures vary across industries. Natural health and food companies tend to have high variable costs because raw materials are significant expenses. Conversely, telecommunications and utility companies often have high fixed costs due to substantial infrastructure investments.

Understanding your industry’s cost structure helps managers develop appropriate strategies. High variable cost businesses should focus on reducing raw material costs and improving production efficiency, while high fixed cost businesses should aim to increase production volume to lower fixed costs per unit.

Summary

Understanding and managing fixed and variable costs are central to effective business management. Knowing which expenses are fixed and which are variable enables managers to make informed financial decisions—from pricing and production planning to cost control and competitive analysis. Both cost types play vital roles in shaping the future of a business. Proper strategic management will lead to stability and sustainable growth.