What Is Fixed Cost Formula? (Definition and Examples)
By Indeed Editorial Team
Updated 28 November 2022 | Published 27 September 2021
Updated 28 November 2022
Published 27 September 2021
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Every business incurs costs during its course of operations. These expenses are categorised into fixed costs and variable costs. It is important for businesses to understand how to calculate fixed costs in order to correctly price their goods and services. In this article, we discuss what the fixed cost formula is, outline the difference between fixed and variable costs, share the steps for how to calculate fixed cost per unit and explore a few examples of fixed cost.
What is the fixed cost formula?
Fixed cost is any kind of business expense that does not alter based on production or sales. Sometimes, fixed costs are also called indirect costs or overhead. The business can not change fixed costs to reduce expenses. Instead, they usually depend on an outside entity, like a landlord or bank. Rent, insurance and labour cost are all examples of fixed costs. Variable costs are business expenses that can change based on sales or production. Merchandise materials and utilities are examples of variable costs.
Usually, businesses calculate the total fixed cost or overall expenses of all individual fixed costs over a short period, such as monthly or half-yearly. While the expenses associated with fixed costs may not change based on sales, they may go up or down depending on other factors. For example, your landlord may increase the rent of your office with time. This can increase your fixed costs but this increase is not related to production or sales. Thus, it is recommended to calculate only your fixed costs in the short term in case these costs fluctuate.
How to calculate fixed cost
There are two methods for calculating fixed costs. The first method works by using this simple formula:
Fixed cost = Total cost of production - (Variable cost per unit x number of units produced)
First, add up all production costs. Note which among these are the fixed cost and variable cost. Take your total cost of production and subtract the variable cost of each unit multiplied by the number of units you produced. This gives you the total fixed cost. The second way to calculate the fixed costs is to tally all of your fixed costs and sum them up. Below are the steps to calculate the fixed cost using the tally method:
1. List all costs
Begin by listing all monthly costs your business incurs. You can make a list by using receipts, budgets and bank account transactions. Expenses paid annually should be divided by 12 to calculate the per month expenses. List every expense and the cost of that expense per month, ideally in a spreadsheet.
Example: Sri Hari Dolls Ltd. makes toy dolls for children. The business needs to calculate its fixed cost in order to set a reasonable price for its product. They make a list of every expense they have per month.
2. Find fixed cost and separate variable costs
Since you are only interested in the fixed costs, itemise the list of expenses by fixed costs (those that do not change based on production or sales) and variable costs (those that are directly impacted by production or sales).
Example: Sri Hari Dolls Ltd. separates its overall list into fixed costs and variable costs. Their fixed costs include building rent (₹ 3,000), employee wages (₹ 80,000), equipment (₹ 2,000) and a website (₹ 200).
3. Add fixed costs
Add together all the individual monthly figures in the fixed cost list. That number represents your monthly total fixed cost.
Example: Sri Hari Dolls Ltd. adds up all its individual fixed costs to calculate its total fixed costs:
₹ 3,000 + ₹ 80,000 + ₹ 2,000 + ₹ 200 = ₹ 85,200
Now, Sri Hari Dolls Ltd. knows they need to account for Rs. 85,200 per month in the price of their dolls. To determine the right price per doll, Sri Hari Dolls Ltd. needs to calculate the average fixed cost.
What is fixed cost per unit?
Fixed cost per unit, also called average cost, assigns a cost to each piece of merchandise to account for all the fixed costs it takes to run the business. The fixed cost per unit helps businesses estimate a price point for their merchandise. It is important to know the fixed cost per unit because the business cannot make a profit if it is not included in the price of the product.
How do you calculate fixed cost per unit?
Calculate fixed cost per unit by dividing the total fixed cost by the number of units for sale. For example, say Sri Hari Dolls Ltd. has 6,000 dolls available for customer purchase. To determine the fixed cost per unit, divide ₹ 85,200 (the total fixed cost) by 6,000 (the number of units for sale). The fixed cost per unit or the average fixed cost is ₹ 14.20. Sri Hari Dolls Ltd. must add ₹ 14.20 to the sales price to make sure they are accounting for the fixed cost.
Say Sri Hari Dolls Ltd. want to increase their profits. One way to do this is to increase production and make more dolls. At the current production rate of 6,000 dolls per month, Sri Hari Dolls Ltd. spends ₹ 14.20 fixed cost per unit. The company is able to expand its production to 8,000 dolls per month. Now, their fixed cost per unit is ₹ 10.65. The company can make an additional ₹ 3.55 in profit per doll sold without adjusting to any spending.
How do you calculate variable costs?
Variable cost is the cost that fluctuates if the volume of goods a business produces varies. The variable cost increases if the production increases, and decreases if the production decreases. The variable cost depends on the variable cost per unit and the number of units produced.
Variable cost per unit is defined as the amount of material, labour or other resources used to produce the product. For example, Sri Hari Dolls Ltd. sells each doll for 300 each but each doll requires Rs. 200 to design, develop, box and market, then the variable cost is Rs. 200. Total units produced are the number of items produced by the company. For example, monthly Sri Hari Dolls Ltd. produces 200 dolls. Thus, the total variable cost is calculated based on the below formula:
Total variable cost = Cost per unit x Total number of units produced
Example: To calculate the variable cost of Sri Hari Dolls Ltd. during the production of 200 dolls, multiply the cost of each doll by the number of dolls produced each month.
Total variable cost for Sri Hari Dolls Ltd. = ₹ 200 x 200 = ₹ 40000
Read more:12 Different Types of Entrepreneurship
Examples of fixed cost
Different businesses may have different fixed cost items. Although, most companies have some commons fixed costs. Here are some examples of such costs:
Labour: It is the amount paid to the workforce working in the factory and office. Labour is mostly on the payroll of the company. They are paid a fixed salary every month.
Licences: Many businesses need permits or licences to run their operations legally, and they often need to pay a fixed price monthly or yearly in order to renew those licenses. For example, restaurants that serve liquor must obtain a liquor licence and renew it every year.
Maintenance: Maintenance covers an array of costs, including expenses for cleaning supplies, machinery repair expenses or annual tune-ups for vehicles. Mostly, this cost remains fixed and is incurred at a set frequency.
Rent: Most businesses pay rent on a monthly basis. The rent may increase after a year, due to which fixed cost is calculated for a short period.
Websites: Most companies have a website to maintain their online presence. They typically pay a fixed amount for web designing, website hosting and search engine optimisation.
Online stores: If your business has an e-commerce store, you can expect a fixed expense on account of e-commerce fees.
Loans: A lot of businesses take loans to start their own business. They often need to pay a fixed monthly amount for loan repayment.
Insurance: It includes transport vehicle insurance, employee insurance, machinery insurance. All these are examples of fixed costs paid by the business.
Property tax: It is the fixed tax a business must pay on its commercial property, such as an office building or factory.
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