How to manage business costs? Essential knowledge about fixed costs and variable costs

In any business operation, a key point that executives and business owners must deeply understand is the cost structure, especially the difference between fixed costs and variable costs, as both types significantly impact decisions related to pricing, investment, and growth planning.

Variable Costs: Flexibility in Management

Let’s start with the costs that can change. Variable Costs (Variable Costs) are expenses that increase or decrease directly with the volume of production or sales. When a business produces more goods or provides more services, variable costs rise accordingly, and vice versa.

Clear Example of Variable Costs

If you own a clothing manufacturing factory, variable costs include:

• Raw materials and production supplies: fabric, thread, buttons, which increase with the number of shirts produced
• Direct labor wages: wages for production line workers paid per piece or hour
• Packaging materials: boxes, bags, tapes for wrapping products
• Transportation and logistics: more sales mean more shipments to customers
• Sales commissions: if paid based on performance, higher sales volume increases costs
• Utilities and utilities: electricity, water used in production increase with output

Advantages of understanding variable costs: Businesses can adjust operations based on market demand and plan production efficiently to maximize profit.

Fixed Costs: Obligations Regardless of Production

Conversely, Fixed Costs (Fixed Costs) are expenses that remain constant regardless of how much the business produces or sells. These costs must be paid continuously, even during periods of low revenue.

Components of Fixed Costs

• Rent: factory, office, warehouse rent, e.g., 100,000 THB per month, regardless of whether you produce 1,000 or 10,000 units
• Salaries of permanent staff: management, accounting staff, administrative personnel receiving full monthly wages
• Depreciation of assets: the decreasing value of machinery, buildings, equipment over time
• Insurance: building insurance, equipment insurance, business risk insurance
• Loan interest: if the business has debt, interest payments are due monthly regardless of profit or loss
• Licenses and permits: business operation licenses, director fees, registration costs

Challenge: High fixed costs can pressure the business

The critical point is that fixed costs like rent and salaries must be paid even when sales decline. This makes startups or small businesses more vulnerable if not carefully planned.

Fixed Costs vs. Variable Costs: Key Differences

Cost Structure’s Impact on Business Decisions

Analyzing total costs (Total Cost), combining fixed and variable costs, is fundamental for many decisions:

1. Pricing Strategy

Selling prices must be high enough to:

• Cover variable costs (raw materials, labor)
• Contribute to fixed costs (rent, salaries)
• Generate profit for growth and reserves

2. Investment in Machinery

If direct labor costs are high, investing in automation machinery can be cost-effective. Although the fixed cost (machine price) increases, the variable cost (labor wages) decreases per unit produced.

3. Growth Planning

Businesses should understand that expanding operations will increase fixed costs, so sales must increase sufficiently to cover these costs.

4. Risk Assessment

Businesses with high fixed costs (such as hotels, airlines) face higher risks during downturns but may earn higher profits when the economy is good.

Cost Management Recommendations

1. Know your costs clearly: Analyze which expenses are fixed and which are variable.
2. Monitor variable costs: Since they fluctuate, aim to reduce them through negotiations with suppliers and improving production efficiency.
3. Control fixed costs without cutting too deeply: Avoid drastic reductions that could harm quality or management systems.
4. Plan for break-even point: Calculate how many units need to be sold to cover all costs, setting realistic sales targets.

Summary

Understanding the difference between fixed costs such as rent, salaries, interest, and variable costs such as raw materials, labor, transportation, is essential knowledge for all managers and business owners. This knowledge helps you make rational decisions regarding pricing, investment, and planning, leading to efficient and financially stable business management in the long term.