Fixed Cost

A fixed cost is a cost that does not change depending on production or sales levels. The cost of running a business is called operating cost. There are two groups of operating costs- the variable cost and the fixed cost. The fixed costs are incurred on a routine basis, regardless of the volume of the business. Examples of fixed costs are depreciation, insurance, interest, rent, salaries, and wages.

Fixed costs incurred by the company are unrelated to fluctuations in productivity or sales. In practice all costs vary over a period of time, indicating that no costs are purely fixed cost. The concept of fixed costs is necessary for short term cost accounting. Though the fixed costs are characterized by regular payments, it does mean it has fixed price. For example the Mortgage on a building is a fixed expense; however the mortgage rates are affected by national interest rates.

The firms with high fixed costs differ from those of with high variable costs. The difference affects the financial structure of the company. It also affects the pricing and profits of the company. A high level of fixed costs increases the operational gearing i.e. the relationship between the sales and the operating profits.

Another example of a fixed cost is electricity. The electricity bill will vary from month to month. The amount of bill is affected by the volume of the business, but there is no possibility that the company may operate for months without the electricity payment. The company may still have to pay for the electricity even if it closes down temporarily owing to the location etc. The unchanging nature if fixed costs may prove to be beneficial for companies with increasing levels of revenue. The fixed costs allow for quicker marginal profitability at high productivity levels. However for the companies who cannot generate more revenue, fixed costs may be debilitating.

Questions:

• What is fixed cost?
• How does fixed cost affect the business in the long run?