# Fixed cost - Easy Explanation

## What is fixed cost?

A fixed cost is a type of cost that does not vary with the level of goods or services produced or sold. It is a cost that remains constant regardless of the volume of production or sales. Fixed costs are also known as overhead costs or indirect costs and are typically not directly related to the production process.

## Examples of fixed cost

Examples of fixed costs include rent, salaries, insurance, and property taxes. These costs are not directly related to the production process, but are necessary for the operation of the business. Fixed costs do not change with the volume of production, and are therefore considered sunk costs.

## Understand the costs and effects in business

Fixed costs are an important concept in business, as they play a significant role in determining the profitability of a company. In order to calculate the profitability of a company, it is necessary to understand the fixed costs as well as the variable costs associated with production.

Variable costs are costs that vary with the level of production. Examples of variable costs include raw materials, labor, and commissions. These costs change as the volume of production changes.

In order to calculate the profitability of a company, it is necessary to understand the relationship between fixed costs, variable costs, and the price of the product or service. The price of a product or service is typically determined by the market, and is not under the control of the company. However, the company can control the fixed and variable costs associated with production.

One way to increase profitability is to decrease fixed costs. This can be done through cost-cutting measures such as negotiating lower rent or reducing the number of employees. Another way to increase profitability is to increase the price of the product or service. However, this is not always possible, as the market will only bear a certain price.

## Fixed cost in contribution margin

In order to calculate the profitability of a company, it is necessary to use the concept of contribution margin. Contribution margin is the difference between the price of a product or service and the variable costs associated with producing it. The contribution margin is used to cover the fixed costs of the company and to generate a profit.

The contribution margin can be expressed as a percentage or as a dollar amount. The contribution margin percentage is calculated by dividing the contribution margin by the price of the product or service. The contribution margin dollar amount is calculated by multiplying the contribution margin percentage by the price of the product or service.

For example, consider a company that produces widgets. The company sells each widget for \$100 and the variable costs associated with producing each widget are \$60. The contribution margin for each widget is \$40 (\$100 - \$60). The contribution margin percentage is 40% (\$40/\$100).

The profitability of the company can be calculated by comparing the contribution margin to the fixed costs. If the contribution margin is greater than the fixed costs, the company is profitable. If the contribution margin is less than the fixed costs, the company is not profitable.

It is important to note that the fixed costs of a company do not have to be constant. A company can choose to increase or decrease its fixed costs depending on its business goals. For example, a company may choose to increase its fixed costs in order to invest in new technology or to expand its operations.

## Conclusion

In conclusion, fixed costs are a type of cost that does not vary with the level of production or sales. They are an important concept in business, as they play a significant role in determining the profitability of a company. Understanding the relationship between fixed costs, variable costs, and the price of a product or service is necessary to calculate the profitability of a company. Fixed costs can be controlled through cost-cutting measures and can be increased or decreased depending on business goals.